10-K 1 a2043757z10-k.txt 10-K U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For Fiscal Year Ended: December 31, 2000 OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________ to ___________. Commission file number 0-27580 NetLojix Communications, Inc. ----------------------------------- (Exact Name of Registrant in Its Charter) Delaware 87-0378021 ------------ -------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 501 Bath Street, Santa Barbara, CA 93101 ---------------------------------------------- ------- (Address of Principal Executive Offices) (Zip Code) (805) 884-6300 -------------------- (Issuer's Telephone Number, Including Area Code) Securities registered under Section 12(b) of the Act: None. Securities registered under Section 12(g) of the Act: Common Stock Par Value $0.01 ----------------------------- (Title of class) Indicate by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained in this form herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant was approximately $1,740,274, computed at the last sale price of such Common Stock on The Nasdaq SmallCap Market as of March 28, 2001. APPLICABLE ONLY TO CORPORATE REGISTRANTS As of March 28, 2001, there were 14,318,423 shares of the Registrant's Common Stock, par value $0.01, issued and outstanding, excluding treasury stock. DOCUMENTS INCORPORATED BY REFERENCE None. TABLE OF CONTENTS
ITEM NUMBER PAGE NUMBER ----------- ----------- PART I 1 Business 2 2 Properties 18 3 Legal Proceedings 19 4 Submission of Matters to a Vote of Security Holders 21 PART II 5 Market for Common Equity and Related Stockholder Matters 21 6 Selected Financial Data 22 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 24 7A Quantitative and Qualitative Disclosures about Market Risk 35 8 Financial Statements and Supplementary Data 35 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 36 PART III 10 Directors and Executive Officers of the Registrant 36 11 Executive Compensation 39 12 Security Ownership of Certain Beneficial Owners and Management 44 13 Certain Relationships and Related Transactions 46 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 47
1 PART I ITEM 1. BUSINESS INTRODUCTORY STATEMENT THIS ANNUAL REPORT ON FORM 10-K CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT") AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN HISTORICAL INFORMATION OR STATEMENTS OF CURRENT CONDITION AND RELATE TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF NETLOJIX. FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF NETLOJIX'S STRATEGIES, PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS. SOME FORWARD-LOOKING STATEMENTS MAY BE IDENTIFIED BY USE OF SUCH TERMS AS "BELIEVES," "ANTICIPATES," "INTENDS" OR "EXPECTS." NETLOJIX'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. NETLOJIX UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. THE CAUTIONARY STATEMENTS MADE IN THIS ANNUAL REPORT SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS ANNUAL REPORT. BACKGROUND GENERAL NetLojix is a provider of network and hosting infrastructure, web application development and technical support to the business market. We provide single-source enterprise-wide solutions integrating our complete portfolio of broadband connectivity, hosting, co-location, web application development, system integration, maintenance and voice connectivity. Our network infrastructure and Internet hosting platform employ proprietary as well as existing technologies that enable our customers to outsource their eBusiness initiatives including hosting, co-location, transaction management, bandwidth, data storage, and security. Our offices and support teams provide design, implementation and management of wide area networks (WANs), local area networks (LANs) and electronic commerce or "eBusiness" solutions, including frame relay, digital subscriber line (DSL), Internet-based virtual private networks (iVPN), voice products transported via the Internet Protocol (VOIP) as well as traditional voice products and Internet access. We offer these services on a stand-alone basis or bundled as part of a total, enterprise-wide solution. We believe that businesses will continue to outsource 2 more of their network infrastructure, systems, server management and system support to companies like NetLojix. Our strategy is to establish NetLojix as an industry leader of hosting and total network management for the mid-size business market by providing a complete, enterprise-wide solution and positioning NetLojix as our customers' "Technology Partner". We believe that our strategy will facilitate the migration of our customer's servers and eBusiness applications off-site and into the NetLojix network. HISTORY The company now known as NetLojix was incorporated on October 31, 1981. Prior to October 23, 1996, NetLojix conducted operations under the name "Hi, Tiger International, Inc." On October 23, 1996, Hi, Tiger International, Inc. acquired AvTel Holdings, Inc, a California corporation. We changed our name to "AvTel Communications, Inc." and implemented a complete change in our board of directors and executive management. As a result of the acquisition, we began to change the focus and the direction of NetLojix. In the intervening years, we have developed a sales and operational strategy to position us as an eBusiness enabler providing advanced Internet, data, and voice connectivity, technical support and application hosting services to the mid-size business market. We now categorize our sources of revenue into three areas: network connectivity, technical support and application hosting and development. We have made additional acquisitions in each of these areas. These acquisitions are identified below: NETWORK CONNECTIVITY |_| In November, 1996, we acquired Silicon Beach Communications, Inc., a provider of Internet services application development and hosting services based in Santa Barbara, California. |_| In February, 1997, we acquired WestNet Communications, Inc., a Ventura, California Internet service provider. Following completion of this acquisition, we began to integrate the customer bases, network facilities and other operations of Silicon Beach Communications and WestNet Communications in order to achieve efficiencies and economies of scale. |_| On December 1, 1997, we acquired Matrix Telecom, a privately-held Texas corporation. At the time of the acquisition, Matrix Telecom was a provider of long distance telephone services to both business and residential customers. See "Background--Acquisition of Matrix Telecom" below. This acquisition provided us with certain carrier agreements, regulatory approvals, licenses, provisioning capabilities and an expanded customer base. Subsequent to the acquisition, we realigned Matrix Telecom to include only residential customers. On November 30, 1999, we sold Matrix Telecom representing all of our residential customer base. See "Sale of Matrix Telecom" below. TECHNICAL SUPPORT SERVICES |_| In November, 1998, we acquired Remote Lojix/ PCSI, Inc., a privately-held corporation based in New York, which is a provider of system integration and local area network services to corporate customers primarily in the eastern United States. This acquisition provided us with 3 the necessary sales, technical resources and service capabilities to initiate our strategy to provide technical support services to our existing and new customers. |_| In August, 2000, we acquired Smith Technology Solutions, Inc., a privately-held corporation based in Northern California which provides technical support services to corporate customers, primarily in California. |_| In September, 2000, we acquired CW Electronic Enterprises, Inc., a privately-held corporation based in Chicago which provides technical support services to corporate customers, primarily in Illinois. APPLICATION DEVELOPMENT AND HOSTING |_| On September 25, 1998, we acquired Digital Media International, Inc., a privately-held corporation based in Santa Barbara, California, which developed software for educational, entertainment and other applications. During 2000, we reduced our focus and capabilities in this area. CORPORATE NAME CHANGE On September 15, 1999, we changed our name to NetLojix Communications, Inc. NetLojix was chosen to reflect our focus on providing enterprise-wide network solutions including communications services and information technology (IT) support. This name change was effected by the short-form merger of a wholly-owned subsidiary with and into NetLojix. ACQUISITION OF MATRIX TELECOM We acquired Matrix Telecom through a stock for stock exchange which was completed on December 1, 1997. In exchange for 100% of the outstanding stock of Matrix Telecom, the Matrix Telecom shareholders received 9,582,000 shares of newly issued common shares of NetLojix, representing approximately 83.9% of the issued common stock of NetLojix. For accounting purposes, the acquisition was treated as a reverse acquisition with Matrix Telecom as the acquirer. In connection with the share exchange, the Matrix Telecom stockholders and NetLojix entered into a registration rights and lockup agreement dated December 1, 1997. Under the agreement, certain persons and entities who held an aggregate of 85.2% of the outstanding Matrix Telecom common stock agreed not to offer, pledge, sell, or otherwise dispose of any shares of NetLojix issued to them pursuant to the terms of the stock exchange agreement for a two year period. The two-year period expired on December 1, 1999. Under the terms of the registration rights and lockup agreement, we are required to use our best efforts to file a shelf registration statement providing for the sale by such stockholders of all securities issued to them in connection with the stock exchange agreement, if requested by such stockholders. We must also use reasonable efforts to keep the shelf registration statement effective on a continuous basis until either (1) all of the shares of common stock are sold or (2) all 4 of the shares of common stock could be sold in a single transaction pursuant to Rule 144 of the Securities Act of 1933. These stockholders may also require us to undertake up to two additional demand registrations of their securities if the shelf registration is not in place. We must pay all costs and expenses of both shelf and demand registrations (excluding any underwriting discounts and fees of counsel to the stockholders As of March 28, 2001, no stockholders have requested NetLojix to file a shelf registration and consequently, the shares remain unregistered. NetLojix's obligations under the registration rights and lockup agreement relate to a total of 6,180,000 shares of NetLojix stock held by the following shareholders: Ronald L. Jensen (329,000 shares), Gladys Jensen (732,000 shares), James J. Jensen (800,000 shares), Jami J. Jensen (852,000 shares), Janet J. Jensen (828,000), Jeffrey J. Jensen (852,000 shares), Julie J. Jensen (852,000 shares), Jenesis Group (187,000 shares), The Janet Foundation (24,000 shares), The OUI Foundation (76,000 shares), The Chasdrew Foundation (24,000 shares), John E. Allen (125,000 shares), Anthony E. Papa (250,000 shares) and James P. Pisani (250,000 shares). At the time of the share exchange, Matrix Telecom was a provider of domestic and international long distance telecommunication services primarily to residential and small business customers in the United States and was licensed to provide telecom services in 49 states. Matrix Telecom's strategy was to compete as a non-facilities based reseller, contracting with Sprint Corporation, Pacific Gateway Exchange, Inc., and other carriers to provide switching and transmission of its customers' traffic. SALE OF MATRIX TELECOM After the purchase of Matrix Telecom, we began to realign our business along customer-oriented business segments. The business customers that were acquired in the Matrix Telecom acquisition were moved to the business markets segment which left Matrix Telecom focused almost exclusively on residential long distance customers. After the time of the share exchange, competitive pressures within the residential long distance market increased dramatically. Pricing pressures reduced retail pricing of long distance products. These factors, similar in nature to those affecting all resellers of long distance telephone services, together with our discontinuation of non-cost effective telemarketing and direct mail marketing, resulted in significant decreases in revenue. This business became overwhelmingly competitive with unprecedented downward pricing pressure and rising customer attrition rates. We also believe that the challenges we experienced in this area overshadowed the substantial growth we experienced in providing data communications services and information technology support to businesses. In August, 1999 we decided to exit the residential long distance business. Our decision was driven by our desire to maximize our focus on our core competency of providing enterprise network solutions to business customers. The sale of Matrix Telecom was the result of our decision to exit the residential long distance business. 5 On November 30, 1999, we sold all of the stock of Matrix Telecom to Matrix Acquisition Holdings Corp., a wholly-owned subsidiary of Platinum Equity Holdings, LLC. The transaction was completed under a Stock Purchase Agreement dated August 31, 1999, as amended. The purchase price for the Matrix Telecom stock was valued at $6,052,000. There were four components to the purchase price. First, we received a credit against future charges incurred for long distance wholesale telephone traffic pursuant to our service contract with Matrix Telecom. We calculated the amount of this credit to be $614,000. Second, the parties eliminated $4,190,000 in intercompany indebtedness owed to Matrix Telecom by NetLojix. Third, we retained federal income tax refunds paid to or due Matrix Telecom in the total amount of $1,248,000. Fourth, we obtained the possibility of receiving a cash payment based upon Matrix Telecom's Internet service customer base (a service which Matrix Telecom has since discontinued). In addition, we received an indemnity from Platinum against certain claims or liabilities arising under our secured credit facility with Coast Business Credit. We also were released by Coast Business Credit from any claims or liabilities relating to borrowings secured by the assets of Matrix Telecom. The amount of the final purchase price is subject to adjustment based on finalization of a balance sheet for Matrix Telecom as of August 31, 1999 and agreement by both parties. We completed the balance sheet and we were notified by Platinum that it materially disagreed with the closing balance sheet that we prepared. We attempted to negotiate a settlement of the balance sheet items in disagreement, but were unsuccessful. To date, the buyer has resisted submitting the matter to an independent firm of accountants chosen by the parties for final resolution, as required by the contract. At this time, we believe that the ultimate resolution of the items in dispute will not materially effect the recorded gain. In connection with the sale, we agreed not to engage in the provision of residential long distance telephone services within the United States prior to August 31, 2002. However, we continue to provide long distance service to our business customers. During the same period we are also prohibited from, directly or indirectly, soliciting the employment of or hiring certain employees of Matrix Telecom. The sale of Matrix Telecom was the result of NetLojix's decision in August, 1999 to exit the residential long-distance business. Consequently, the residential long-distance business has been reflected as a discontinued operation and all prior period amounts have been restated. BUSINESS OF THE COMPANY We provide network technology and management services that enable small to mid-sized businesses to effectively operate in the increasingly complex world of electronic commerce and communications. The services we provide include advanced Internet, data, and voice connectivity, technical support and application development and hosting services. We are a single-source provider of enterprise network solutions integrating our complete portfolio of broadband connectivity; applications development and hosting; and system integration and maintenance. Our offices and support teams provide design, implementation and management of LAN, WAN and 6 eBusiness solutions, including frame relay, DSL, iVPN, VOIP and Internet access. We offer these services on a stand-alone basis or bundled as part of a total solution. SERVICES We target the enterprise networking needs of mid-size corporate customers. Our objective is to become a leading single-source provider of network connectivity, technical support, and application hosting. This includes Internet access, data transport and voice services; systems integration, IT service and technical support; and web-centric application hosting. Through a value-added sales process, we design, install and manage our customers' networks. We also provide a host of additional value-added services assisting our customers to create enhanced Intranet and extranet applications. We believe this strategy of focusing on the corporate customer for enterprise-wide network solutions offers significant opportunity. We are able to cross-market to our customer base a variety of traditional telecommunications products and services such as long distance telephone service, executive calling cards and video/audio conferencing as well as eBusiness and IT maintenance and support services. NetLojix is organized into three primary business segments: network connectivity, technical support services and application development and hosting. The network connectivity segment, which accounted for 55.9% of NetLojix's revenue for the year ended December 31, 2000, includes traditional long distance services, calling card, dedicated voice and data access and numerous Internet service options. The technical support services segment accounted for 31.5% of NetLojix's revenues in 2000. This segment's services include flat-fee maintenance contracts, prepaid time block retainers, help desk management contracts, LAN installations, warranty repairs and a small amount of hardware sales. The final segment is applications development and hosting services, which contributed 12.6% of 2000 revenue. Its services include producing, designing, and programming creative multimedia applications that can be produced as a web application or a stand alone application as well as web hosting services. MPOP STRATEGY. In early 2000, we began to implement a facilities-based network strategy which included the deployment of multi-service points-of-presence ("mPOPs") in select target markets. mPOPs are router-based network access points that allow us to provide services we currently do not provide in certain markets, give us greater control over portions of the network we provision for our customers and therefore provide a higher quality of service. We utilize local access providers including local exchange carriers ("LEC's"), competitive local exchange carriers ("CLEC's"), DSL providers and wireless carriers to interconnect customer locations with our mPOP network. Each mPOP is connected to the Internet through high-speed, broadband facilities provided by alternative carriers. The mPOP strategy provides us with additional transport facilities for other frame relay and ATM data services. Each mPOP is equipped with, among other things, Cisco data routing equipment and other systems as required to provide transport and hosting services. mPOPs provide NetLojix greater network flexibility and control and cost benefits in providing certain data services to our customers. We currently operate mPOPs in Santa Barbara, San Francisco and Los Angeles, California 7 and New York, New York. We also operate nine smaller virtual points-of-presence on the Central Coast of California. NetLojix will continue to evaluate network deployment opportunities relative to what is available in the carrier resale arena. INDUSTRY. Information technology has fast become a driving force in telecommunications. Our strategy is driven by corporate end users' needs for network connectivity, integration and support as a result of new software applications and technology advancements developed in the information technology arena. This has become a critical element in the ability of businesses, professional and other organizations to improve productivity and lower costs. This can be accomplished through the use of a variety of communications services, including branch office, remote office and telecommuter networking ("intranets") as well as providing network access to customers, vendors, suppliers ("extranets") and the Internet. While we expect these factors to continue to increase market demand for these services, there are no assurances regarding the size of such demand or that NetLojix will be selected to provide its services in response to such demand. INTERNETWORKING. At an increasing rate, business, professional and other organizations are seeking to inter-network their local area networks, wide area networks and virtual private networks to share information and computing resources for applications such as e-mail, transaction processing, the sharing of databases, multi-site engineering, product development and electronic image transfer. The communications traffic of many organizations has grown steadily during the past two decades leading to enterprise-wide networks facilitating rapid and efficient data communications between work groups, departments and branch locations. Additionally, a shift to enterprise-wide remote access has occurred due to increased business mobility, increased telecommuting, reduced cost of wide area network services and widespread adoption of remote access standards. Internet and remote access devices extend the organization network beyond the branch office, bringing remote users closer to the enterprise and permitting connection to the corporate local area network so users can work anywhere, any time. Users can access e-mail, databases and servers as if they were in the corporate office. The recent availability of reliable Internet protocol voice technology within an enterprise-wide data network has created additional cost-saving incentives for businesses to implement advanced network solutions. We believe that, as a result of these shifts, internetworking, the method used for interconnecting networks, will continue to grow. This is reflected in the growth in sales and distribution of routers, remote access servers, intranet software and other various components that enable Internetworking. As the computing paradigm continues to migrate to Web-centric architectures, enterprise-wide networks allow those technologies to be implemented. Our strategy recognizes the opportunity to bridge the gap between telecom and computer providers and simplify networking complexities by becoming a single source for enterprise-wide services and support. 8 CONNECTIVITY AND BANDWIDTH. We believe that communications requirements such as bandwidth availability and network design are replacing computer requirements such as processor speed, memory or operating systems as the delimiting factors for business applications. Video conferencing, remote patient diagnostics with medical imaging and telecommuting are all business applications in which the success of the deployment is defined by the available bandwidth. The ultimate realization of this trend is the Web and applications developed with Internet-specific tools. Web-based applications are computer platform and operating system independent but depend entirely upon connectivity and bandwidth for successful deployment and execution. As a result, connectivity has become one of the most important factors in enhancing business productivity and customer service. Large corporations have historically created private wide area networks through leased dedicated data lines. However, dedicated point-to-point facilities have several deficiencies: leased lines are very expensive; remote offices and telecommuters are omitted; and leased lines are not suited for unscheduled and asynchronous communications. Accordingly, small and medium size companies that have sought the benefits of Internetworking have been required to use modems and dial-up telephone lines which are generally too slow to handle today's applications. Growing demands for high speed capabilities have given way to the emergence of new carrier-based data communication services to overcome the deficiencies of both dedicated leased and dial-up lines. Wide area network solutions vary substantially depending on an organization's size and communications needs. Traditionally, wide-band digital transmission circuits (such as T1 and DS-1) were leased from public carriers to provide voice, fax and data communications links between larger offices and low speed leased lines (such as DS-O) for branch office connectivity. For some applications, however, this has proven expensive and inefficient because the entire bandwidth capacity is dedicated 24 hours per day, whether or not it is used. Packet-based services were developed to address the issue of allocation and utilization. Today, "fast packet" networking technologies such as Frame Relay and Asynchronous Transfer Mode have emerged as an integrated, cost-effective, flexible wide area network solution. These networks allow for "bandwidth on demand" between any two endpoints on a wide area network. STRATEGY. The implementation of our strategy involves the marketing of products and services integrated into enterprise-wide network solutions for business customers. These enterprise-wide solutions include network design, system integration and technical support, wide area network connectivity, voice connectivity, Internet access and Web development, hosting and co-location. NetLojix's sales and marketing activities result in monthly, recurring revenues from networking customers under term agreements. Our sales strategy includes in-house direct sales professionals and, on a limited basis, an agent program through which we distribute our services through value-added resellers (VARs) of information technology products. We leverage the existing customer relationships of these VARs gaining more immediate access to a wider group of prospective customers and greater credibility in the sales process. Additionally, this VAR 9 channel becomes the service organization for our business customers requiring on-site repair and maintenance visits in remote markets. CUSTOMERS Our customers are primarily small to mid-size business owners and are located in many geographic regions of the United States. There are slight concentrations around NetLojix's offices in New York, Chicago, Fort Worth, Texas and California. For the twelve months ended December 31, 2000, one customer (S.G. Cowen) in the Technical Support Services segment comprises approximately 11.8% of the Company's revenue. REGULATION The services which NetLojix provides, either directly or through our subsidiaries, are subject to varying degrees of federal, state and local regulation. The Federal Communications Commission exercises jurisdiction over all facilities of, and services offered by, telecommunications common carriers to the extent that they involve the provision, origination or termination of jurisdictionally interstate or international communications. The state public service commissions retain jurisdiction over jurisdictionally intrastate communications. The Federal Communications Commission and relevant public service commissions have the authority to regulate interstate and intrastate rates, respectively, ownership of transmission facilities and the terms and conditions under which our services are provided. In general, neither the Federal Communications Commission nor the relevant state public service commissions exercise direct oversight over cost justification for our services or profit levels, but either or both may do so in the future. However, we are required by federal and state law and regulations to file tariffs listing the rates, terms and conditions of services provided. We are also generally required to obtain certification from the relevant state public service commission prior to the initiation of certain intrastate service, and are required to maintain a certificate issued by the Federal Communications Commission in connection with the provision of certain international services. Any failure to maintain proper federal and state tariffs or certification or any difficulties or delays in obtaining required authorization could have a material adverse effect on our business. In order to continue providing long distance telephone services to our business customers after the sale of Matrix Telecom, we formed NetLojix Telecom, Inc., a wholly-owned subsidiary of NetLojix, which has obtained Section 214 authority from the Federal Communications Commission and operating authority from all 49 states in which Matrix Telecom was qualified or registered. COMPETITION The telecommunications and information technology industries are highly competitive and 10 affected by rapid regulatory and technological change. We face substantial and growing competition from a number of telecommunications service providers, Internet service providers and technical support service providers. We do not believe that a significant number of other companies are providing the bundle of services for enterprise-wide network solutions or a comparable range of services integrating Internet, data and voice connectivity and technical support to mid-sized businesses. However, we do face intense competition in each of our individual product and service offerings. Our network connectivity services offerings compete directly with traditional long distance carriers, facilities based carriers as well as Internet and web service providers. Our technical support services competes both directly and indirectly with IT consulting firms and computer equipment resellers. We believe that the principal competitive factors in our business include pricing, customer service, network quality, service offerings and the flexibility to adapt to changing market conditions. Our future success depends in part upon our ability to compete with national and local telecommunications providers, national and local Internet service providers, and small and large network services providers, many of which have considerably greater financial and other resources than us. INTELLECTUAL PROPERTY We use several unregistered trademarks in our marketing materials. These include NetLojix(TM), mPOP(TM), Silicon Beach(TM), WestNet Communications(TM), Remote Lojix(TM), Addictive Media(TM) and Digital Meteor(TM), which WE MAY Seek to register. While these trademarks are important to our business, we do not believe that failure to register these trademarks poses any material risk of infringement on our rights to use such trademarks. We are currently in litigation with Netlogic, Inc. in connection with our use of the name NetLojix. See "Item 2. Legal Proceedings," below. EMPLOYEES As of March 15, 2001, NetLojix and our subsidiaries had 129 full-time employees. None of the employees are represented by a union. We supplement our work force from time to time with contractors, administrative personnel through employment agencies, and part time employees. We believe that we have good relations with our employees. RISK FACTORS IN EVALUATING NETLOJIX, ITS BUSINESS, OPERATIONS AND FINANCIAL POSITION, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS FORM 10-K. THE 11 FOLLOWING FACTORS, AMONG OTHERS, COULD AFFECT NETLOJIX'S ACTUAL FUTURE OPERATING RESULTS AND COULD CAUSE SUCH RESULTS TO DIFFER FROM THE RESULTS DISCUSSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY OR ON BEHALF OF NETLOJIX. WE HAVE EXPERIENCED SIGNIFICANT LOSSES FROM CONTINUING OPERATIONS IN EACH OF THE LAST THREE YEARS AND WE MAY CONTINUE TO EXPERIENCE LOSSES FOR THE FORESEEABLE FUTURE We have incurred significant losses from continuing operations in each of the last three years and we may continue to lose money for the foreseeable future. We have not generated enough revenue to offset the substantial amounts that we have spent to grow our business, and we plan to continue to incur significant expenses. WE MAY NEED TO RAISE ADDITIONAL CAPITAL Historically, our cash flow from operations, our secured borrowings, our private placements and our equity line agreement with Cambois Finance, Inc. have been sufficient to meet working capital and capital expenditure requirements. However, we currently cannot utilize the equity line without the agreement of Cambois. We have taken several steps to conserve cash and reduce operating expenses. These steps include the termination of 30 employees, which was effected on November 9, 2000. After giving effect to the cost control measures, we expect that operating cash flows coupled with the remaining availability under our secured line of credit facility should be sufficient to meet our minimum working capital requirements into the foreseeable future. While we believe the cost control measures will significantly reduce our monthly cash requirements, we are also exploring other possible sources of cash including the possibility of a private equity placement. However, our current low stock price and our possible delisting from The Nasdaq SmallCap Market (described below) present substantial obstacles to additional private placements. THE STOCK PRICE IS VOLATILE Trading in our stock was halted by Nasdaq after the close of trading on November 12, 1998, through the close of trading on November 13, 1998, as a result of an unusual upsurge in its stock price and trading volume. See "Business - Legal Proceedings." The trading volume of the common stock has been variable, but often low. As a result, relatively small trades may significantly affect the market price of the common stock. The market price of the shares of common stock has been highly volatile and may be significantly affected by factors such as actual or anticipated fluctuations in our operating results, announcements of potential acquisitions, changes in regulations, activities of the largest domestic providers, industry consolidation and mergers, conditions and trends in the market, adoption of new accounting standards affecting the industry, changes in recommendations and estimates by securities analysts, general market conditions and other factors. The possible delisting of our stock from The Nasdaq SmallCap Market could worsen this volatility. In addition, the stock market has from time to time 12 experienced significant price and volume fluctuations that have particularly affected the market prices for the shares of emerging growth companies like NetLojix. Many of these factors are beyond our control. THE MARKET PRICE OF OUR COMMON STOCK MAY BE ADVERSELY AFFECTED IF WE ARE DELISTED FROM THE NASDAQ SMALLCAP MARKET BECAUSE WE FAILED TO CONTINUE TO MEET THE LISTING STANDARDS On March 23, 2001, we received a Nasdaq staff determination indicating that NetLojix fails to comply with the net tangible assets and minimum bid price requirements for continued listing on The Nasdaq SmallCap Market. As a result NetLojix's stock is therefore subject to delisting from The Nasdaq SmallCap Market. On March 28, 2001, we requested a hearing before a Nasdaq listing qualifications panel to review the staff determination. A hearing has been scheduled for May 11, 2001. NetLojix's stock will continue to be listed on The Nasdaq SmallCap Market pending the panel's decision. There can be no assurance that the panel will grant NetLojix's request for continued listing. If NetLojix's stock is delisted, it will be eligible for quotation on the OTC Bulletin Board. We expect that, upon delisting, the price, volume of transactions, and liquidity of the common stock would, in all likelihood, be adversely affected. WE ARE A DEFENDANT IN A SECURITIES CLASS ACTION LITIGATION As noted above, on November 12, 1998, we experienced an unusual upsurge in our stock price and trading volume. This unusual event has triggered the initiation of class action litigation under the federal securities laws. We have entered into a settlement agreement with counsel for the plaintiff class. However, this settlement has not been finalized. See "Business-Legal Proceedings." If the settlement is not consummated, our operating results and financial condition could be adversely affected by an adverse outcome of this litigation. Even if we prevail in the litigation, the expenses of the defense could have a material adverse effect on our operating results and financial condition. WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY In September 1999, we integrated our services under a single enterprise network solutions offering. Previously, our telecommunications services, IT services, Internet services and applications hosting services were marketed separately under separate company names and marketing channels. We believe there are significant opportunities for our single source strategy for the mid-sized business. However, the industries in which we compete are intensely competitive and subject to rapid change. We compete with telecommunications services providers, technical support providers, web development companies and other Internet service providers. Within the telecommunications industry, competitors include facilities-based and non-facilities-based providers, many of which have substantially more resources than us. Providers compete on the basis of price, customer service, transmission quality, breadth of service offerings and value-added services. 13 The technical support industry is characterized by numerous competitors offering one or more services that we provide. We compete with PC vendors and PC resellers for maintenance and extended warranty services and large IT consulting firms for our "help" desk and IT facilities management services. In addition, there are numerous small companies that compete effectively for technical support services within one or more industry specific niche markets or geographic areas. Certain competitors are substantially larger than we are and have greater financial, technical, service, and marketing resources. We also compete with all Internet service providers that provide web hosting and design. Many of our competitors are substantially larger than we are and have substantially greater financial, infrastructure and personnel resources than we have. Furthermore, many of our competitors have well established large and experienced marketing and sales capabilities and greater name recognition. WE MUST KEEP PACE WITH TECHNOLOGICAL CHANGE TO REMAIN COMPETITIVE Our business is in a period of rapid technological evolution, marked by the introduction of competitive product and service offerings, such as the use of the Internet for international voice and data communications, the use of the web for business connectivity and rapidly changing commercial uses of the Internet. Our future success depends, in part, on our ability to use leading technologies effectively, to develop technological expertise, to enhance existing services and to develop new services that meet changing customer needs on a timely and cost-effective basis. We are unable to predict which technological development will challenge its competitive position or the amount of expenditures that will be required to respond to a rapidly changing technological environment. If we fail to respond in a timely and effective manner to new and evolving technologies it could have a negative impact on our operating results and financial condition. WE ARE DEPENDENT ON TELECOMMUNICATIONS CARRIERS AND OTHER SUPPLIERS We rely on traditional telecommunications carriers to transmit our traffic over local and long distance networks. These networks may experience disruptions that are not easily remedied. In addition, we depend on certain suppliers of hardware and software. If the suppliers fail to provide network services, equipment or software in the quantities, at the quality levels or at the times we require, it will be difficult for us to provide services. REGULATORY AND LEGAL UNCERTAINTIES COULD HARM OUR BUSINESS Our business is subject to various federal and state laws, regulations, agency actions and court decisions, some of which impose prior certification, notification, registration and/or tariff requirements. As noted above, NetLojix Telecom, a subsidiary of NetLojix, has Section 214 authority from the Federal Communications Commission and operating authority from 49 states. Certificates of authority can generally be conditioned, modified or revoked by state regulatory 14 authorities for failure to comply with state laws and regulations. Fines and other penalties may be imposed. The loss of a certificate of authority or the imposition of fines or other penalties could have a material effect on our business, operating results and financial condition. In addition, future changes in any of these sources of regulation could have a material adverse effect on our business, operating results and financial condition. OUR EXECUTIVE OFFICERS, DIRECTORS AND EXISTING STOCKHOLDERS WILL HAVE THE ABILITY TO EXERCISE SIGNIFICANT CONTROL Executive officers, directors and members of their families beneficially own, in the aggregate, approximately 49% of our outstanding common stock. These stockholders will be able to exercise effective control over all matters requiring approval by our shareholders, including the election of directors and the approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying or preventing a change of control, which could negatively affect the stock price. FUTURE SALES OF COMMON STOCK MAY NEGATIVELY AFFECT OUR STOCK PRICE If requested by certain shareholders, we are required to register for resale 6,180,130 shares of common stock that are held by executive officers and directors of NetLojix, members of their families and certain charitable foundations, pursuant to a registration rights and lockup agreement. The market price of our common stock could decline as a result of sales of a large number of shares of NetLojix common stock in the market, or the perception that such sales could occur. These sales might also make it more difficult for us to sell equity securities in the future at a time that we consider appropriate. THE ISSUANCE OF SHARES UNDER THE EQUITY LINE AGREEMENT MAY DILUTE OUR COMMON STOCKHOLDERS AND ADVERSELY AFFECT THE STOCK PRICE On April 23, 1999, we entered into an equity line agreement with Cambois Finance, Inc., a British Virgin Islands corporation engaged in the business of investing in publicly-traded equity securities. Under the equity line agreement, subject to the satisfaction of certain conditions, we may issue or sell, from time to time, up to an aggregate of $13,500,000, after deducting discounts, of our common stock. NetLojix has sold an aggregate of $2,000,000 of common stock to Cambois Finance under the equity line agreement; however, NetLojix has not sold any shares to Cambois under the equity line agreement since December 1999. The equity line agreement provides that the number of shares that can be put to Cambois Finance is based on a floating rate that will be below the market price of the common stock. As a result, the lower the stock price goes, the more common stock that Cambois Finance receives. The following table illustrates the number of shares that NetLojix would be required to issue if it chooses to raise additional capital under the equity line, at various assumed prices pursuant to the equity line agreement, subject to the limitations described in the text following the table, and the percentage of outstanding stock that would be owned by existing stockholders as a result of the issuance of NetLojix common stock at the 15 indicated price. NetLojix currently does not have the ability to put any shares to Cambois without Cambois's agreement. The table is for illustrative purposes only, and you should not assume that it represents NetLojix's "best guess" of the range of future prices.
ASSUMED SHARES ISSUABLE UNDER THE OWNERSHIP OF EXISTING NETLOJIX LOW CLOSING EQUITY LINE STOCKHOLDERS AS A RESULT OF BID PRICE(1) AGREEMENT SHARE ISSUANCE(2) $0.0547 236,276,083 5.71% $0.1094 118,138,042 10.80% $0.1641 78,758,694 15.37% $0.2188(3) 59,069,021 19.50% $0.2734 47,255,217 23.24% $0.3281 39,379,347 26.65% $0.3828 33,753,726 29.77%
-------------- (1) NetLojix does not have the right to put common stock to Cambois unless the low closing bid price determined at the date of the put is at least $2.26. (2) Based on 14,318,423 shares outstanding on March 28, 2001. (3) Low closing bid price for a share of NetLojix common stock on March 28, 2001. Notwithstanding the conversion formulas, in order to comply with the listing requirements of the Nasdaq SmallCap Market the equity line agreement provides that, without a vote of NetLojix's common stockholders, NetLojix may not issue more than 2,104,000 shares of common stock in the aggregate to Cambois Finance under the equity line, which number of shares is equal to 19.96% of the outstanding shares of NetLojix common stock on the date of the equity line agreement. As of March 28, 2001, NetLojix had sold an aggregate of 1,067,000 shares to Cambois Finance under the equity line agreement. As a result, NetLojix could sell up to an additional 1,037,000 shares to Cambois Finance without obtaining stockholder approval. In order to issue shares in excess of that amount under the equity line agreement, NetLojix would have to register additional shares with the Securities and Exchange Commission, as well as obtain stockholder approval. If NetLojix is delisted from The Nasdaq SmallCap Market, NetLojix will be unable to utilize the equity line agreement without Cambois's approval even if the bid price for NetLojix's stock goes above $2.26 per share. The significant downward pressure on the price of the common stock as a result of sales by Cambois Finance could encourage short sales. This could exert further downward pressure on the price of NetLojix common stock. 16 WE ARE DEPENDENT ON KEY MANAGEMENT PERSONNEL FOR OUR FUTURE SUCCESS Our success depends to a significant degree upon the efforts of senior management personnel, in particular, Anthony E. Papa, Chairman and Chief Executive Officer, and James P. Pisani, President and Chief Operating Officer. The departure of any officers or key employees could materially adversely affect our ability to implement our business plan. WE MAY NOT BE ABLE TO HIRE AND RETAIN QUALIFIED EMPLOYEES We believe that our future success will depend in large part upon our continuing ability to attract and retain highly skilled personnel. Competition for qualified, high-level telecommunications personnel is intense and there can be no assurance that we will be successful in attracting and retaining qualified personnel. The loss of the services of one or more of our key individuals, or failure to attract and retain other key personnel, could materially adversely affect our business, operating results and financial condition. WE MAY NOT BE ABLE TO SUCCESSFULLY MAKE ACQUISITIONS OF OTHER COMPANIES An important component of our past growth has been to develop our business through acquisitions. This growth strategy is dependent on the continued availability of suitable acquisition candidates and subjects us to a number of risks. Acquisitions may place significant demands on our financial and management resources, as the process for integrating acquired operations presents a significant challenge to management and may lead to unanticipated costs or a diversion of management's attention from day-to-day operations. There can be no assurance that we will be able to successfully integrate into its operations any acquisitions it makes in the future. FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-K, including without limitation, statements containing the words "believes," "anticipates," "intends," "expects" and words of similar import, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of NetLojix to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, those set forth above. GIVEN THESE UNCERTAINTIES, THE STOCKHOLDERS OF NETLOJIX ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS. 17 ITEM 2. PROPERTIES We do not own any real property. The table below sets forth certain information with respect to the material properties that we lease, including the executive offices in Santa Barbara, California. All of such properties consist of office space. NetLojix and subsidiaries also operate points-of-presence for the purpose of creating local access points to its network backbone.
CURRENT MONTHLY LOCATION SQUARE FEET EXPIRATION DATE(2) RENT(1) 501 Bath Street 6,798 March 2003 $12,353 Santa Barbara, CA 104 West Anapamu (3) 5,432 November 2001 $8,826 Suites C, D, E & M Santa Barbara, CA 1024 Serpentine Lane 2,862 July 2003 $5,152 Suite 107 Pleasanton, CA 70 West 36th St. 2,500 December 2002 $5,000 Suite 605 New York, NY 38 East 32nd St. 4,400 February 2004 $4,583 8th Floor New York, NY 1600 Parkwood Circle (4) 2,190 December 2001 $3,890 Suite 603 Atlanta, GA 519 W. Golf Road 5,850 October 2006 $3,778 Arlington Heights, IL 2333 Mill Creek Drive 1,643 February 2002 $3,532 Suite 120 Laguna Hills, CA 7001 Grapevine Highway 3,183 May 2005 $3,382 Suite 525 North Richland Hills, TX
18 --------------------- (1) All amounts shown are on a triple net basis. (2) Subject to certain renewal options held by NetLojix. (3) Expires as to the majority of the space in November 2001. Expires as to other portions of the space in April 2002 and May 2005. Approximately half of the space is subleased to an unrelated third party for the balance of the lease term for $4,291 per month. (4) Subleased to an unrelated third party for the balance of the lease term for $3,385 per month. In addition, NetLojix leases two other facilities, primarily as sales offices. The rent on these facilities is less than $3,000 per month per facility. ITEM 3. LEGAL PROCEEDINGS As previously reported, NetLojix is a defendant in a class action under the federal securities laws (IN RE AVTEL SECURITIES LITIGATION, Case No. 98-9236) currently pending in the United States District Court for the Central District of California. On October 4, 2000, NetLojix finalized an agreement with counsel for the plaintiff class to settle all outstanding claims under the class action lawsuit. This agreement received the preliminary approval of the court on November 8, 2000, and NetLojix thereafter paid $150,000 for administrative costs and other settlement implementation expenses. Notice of the settlement was distributed to potential class members on March 19, 2001. The court will hold a hearing, now scheduled for May 14, 2001, to consider the entry of a final order of dismissal and approval of the settlement. If so approved, NetLojix will then issue for distribution to the claimant class members, and payment of any plaintiffs attorneys' fees and litigation expenses as the court may award, 232,000 shares of common stock and warrants to purchase 200,000 shares of NetLojix's common stock at an exercise price of $8.00 per share with a term of 2 years. While NetLojix continues to believe it has strong defenses against the lawsuit, considering the ongoing costs of defending the lawsuit in terms of management time and legal fees as well as the uncertainty associated with a jury trial, NetLojix believes the settlement is fair and equitable. During the three month period ended March 31, 2000, NetLojix recorded a charge against earnings of $998,000 and a liability relating to the expected settlement. NetLojix, Matrix Telecom, Inc. (a former subsidiary of NetLojix), Ronald L. Jensen and United Group Association, Inc. (an entity affiliated with Mr. Jensen) are defendants in an action pending in the District Court of Dallas County, Texas, which was filed in May, 1999, by E. Craig Sanders. Mr. Sanders was an executive of Matrix Telecom from late 1994 until he was terminated by Matrix Telecom in May 1995. The complaint alleges that Mr. Jensen wrongfully foreclosed on Matrix Telecom stock owned by Mr. Sanders after Mr. Sanders failed to repay a debt to Mr. Jensen. Matrix Telecom then repurchased the stock from Mr. Jensen pursuant to an existing buy/sell agreement with Mr. Sanders. In addition to his claim against Mr. Jensen, Mr. Sanders is apparently seeking 171,548 shares of NetLojix's common stock, or its monetary equivalent, from NetLojix. 19 NetLojix and Matrix Telecom have filed an answer denying the allegations of this complaint. Discovery in the matter has been completed, and each side has filed a motion for summary judgment NetLojix expects that the summary judgment motions will be heard by the court on April 5, 2001. Trial is set for April 16, 2001. NetLojix intends to defend this complaint vigorously. NetLojix filed suit on April 5, 2000 in the Santa Barbara County Superior Court against Netlogic, Inc., a Delaware corporation having a principal place of business in New York. The action has been transferred to the United States District Court for the Southern District of New York. NetLojix filed this action after its receipt of a cease and desist letter from Netlogic demanding that NetLojix cease all usage of the trademark NETLOJIX. The district court action seeks a declaration of non-infringement and cancellation of the trademark registration for NETLOGIC, which the defendant allegedly obtained from the U.S. Patent and Trademark Office. Subsequently, Netlogic filed suit against NetLojix and certain of its subsidiaries in the United States District Court for the Southern District of New York alleging trademark infringement. The complaint seeks an injunction against the use of the trademark NETLOJIX, and various unspecified damages relating to the use of that trademark. NetLojix believes the claims lack merit. NetLojix's complaint and Netlogic's complaint will be tried together. The matter is currently in the discovery phase, and no trial date has been set. NetLojix is currently in settlement discussions with Netlogic, but there is no assurance the matter can be settled on satisfactory terms. In the absence of a satisfactory settlement, NetLojix intends to aggressively pursue its claims in the actions with Netlogic; however, it is not possible to predict with any certainty the outcome of the litigation. In June 2000, Ellen Dawson, a former employee of NetLojix, filed suit against NetLojix in the Superior Court for Orange County, California, alleging gender discrimination and retaliation. Ms. Dawson is apparently seeking damages (including punitive damages) in excess of $450,000 together with her attorney's fees. NetLojix believes that Ms. Dawson's claims are without merit, and intends to defend this complaint vigorously. Trial is scheduled for July 16, 2001. On July 25, 2000, DNS Communications, Inc. was served with a Complaint filed in the state court for Harris County, Texas, entitled, Transnational Telesis, Inc. v. DNS Communications, Inc f/k/a Direct Network Services, Inc., Matrix Telecom, Inc. and Group Long Distance, Inc.. DNS was formerly a subsidiary of Matrix Telecom and is currently a subsidiary of NetLojix. Matrix Telecom was formerly a subsidiary of NetLojix. The complaint alleges that DNS entered into a marketing agreement with Transnational Telesis pursuant to which DNS was to pay certain commissions to Transnational based on the telephone usage of customers obtained for DNS by Transnational. The complaint further alleges that DNS failed to make commission payments that were due. The complaint alleges causes of action for breach of contract, unjust enrichment, punitive damages and attorneys fees, based on the alleged failure to pay commissions, and seeks unspecified damages in excess of $10,000. Discovery in the matter has just begun. 20 NetLojix is not aware of any proceedings against it contemplated by any governmental authority. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Since May 28, 1998, our Common Stock has been traded on The Nasdaq SmallCap Market. The trading symbol is "NETX." Until September 15, 1999, the stock traded under the trading symbol "AVCO". There is no established public trading market for NetLojix's Preferred Stock. The following table sets forth, for the indicated periods, high and low sales prices for NetLojix's Common Stock. Such information was provided by Nasdaq, various market makers and on-line quote reporting services. The quotations provided reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. YEAR ENDING DECEMBER 31, 1999 HIGH LOW ----------------------------- ---- --- First Quarter $12.50 $4.00 Second Quarter $8.75 $3.75 Third Quarter $4.88 $1.63 Fourth Quarter $8.50 $1.63 YEAR ENDING DECEMBER 31, 2000 First Quarter $8.50 $2.72 Second Quarter $5.84 $1.88 Third Quarter $3.38 $1.50 Fourth Quarter $1.88 $0.13
The number of shareholders of record of NetLojix Common Stock as of March 28, 2001, was 569. At that date there were two record holders of NetLojix Preferred Stock. On March 23, 2001, we received a Nasdaq staff determination indicating that NetLojix fails to comply with the net tangible assets and minimum bid price requirements for continued listing on The Nasdaq SmallCap Market. As a result NetLojix's stock is therefore subject to delisting from The Nasdaq SmallCap Market. We have requested a hearing before a Nasdaq listing qualifications 21 panel to review the staff determination, but there can be no assurance that the panel will grant NetLojix's request for continued listing. If NetLojix's stock is delisted, it will be eligible for quotation on the OTC Bulletin Board. We have not paid any cash dividends on our Common Stock to date and we do not anticipate paying dividends in the foreseeable future. We intend to utilize all available funds for the development of our business. The terms of NetLojix's Series A Convertible Preferred Stock prevent the payment of any dividend on the Common Stock unless (1) all cumulative dividends on the Series A Convertible Preferred Stock have been fully paid, and (2) the holders of at least 50% of the outstanding shares of the Series A Convertible Preferred Stock have approved such dividend. In addition, the terms of our secured credit agreement provide that NetLojix cannot declare a dividend on any of its ownership interests without the secured lender's approval. ITEM 6. SELECTED FINANCIAL DATA For accounting purposes, the acquisition of Matrix Telecom on December 1, 1997 was treated as a reverse acquisition of NetLojix by Matrix Telecom. Accordingly, our results of operations reflect the operations of Matrix Telecom prior to December 1, 1997 and reflect the combined operations of NetLojix and Matrix Telecom subsequent to December 1, 1997. In August, 1999, we decided to exit the residential long distance business. Consequently, the residential long-distance business has been reflected as a discontinued operation and all prior period amounts have been restated. The following selected operations data of NetLojix for the years ended December 31, 2000, 1999, 1998, 1997 and 1996 and balance sheet data as of December 31, 2000, 1999, 1998, 1997 and 1996 have been derived from our (or Matrix Telecom's) audited financial statements. These selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and notes thereto included elsewhere herein. 22
STATEMENT OF OPERATIONS DATA: YEARS ENDED DECEMBER 31, 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Revenues $20,703,000 $16,864,000 $9,888,000 $6,435,000 $6,917,000 Operating income (loss) (6,786,000) (4,890,000) (3,467,000) (9,275,000) 398,000 Income (loss) from continuing operations (6,923,000) (4,947,000) (3,271,000) (9,213,000) 238,000 Income (loss) from discontinued operations -- 2,750,000 (2,531,000) (979,000) 2,329,000 Net income (loss) (6,923,000) (2,198,000) (5,802,000) (10,192,000) 2,567,000 Loss per common share from continuing operations-basic and diluted (0.51) (0.49) (0.35) (1.11) N/A Income (loss) per common share from discontinued operations -- 0.26 (0.26) (0.12) N/A Net loss per common share- basic and diluted (0.51) (0.23) (0.61) (1.23) N/A Cash dividends per common share -- -- -- -- --
---------------- N/A - Not applicable BALANCE SHEET DATA:
AS OF DECEMBER 31, 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Working capital (deficit) ($3,830,000) $647,000 ($2,084,000) $5,571,000 $6,963,000 Total assets 11,719,000 10,514,000 10,725,000 10,971,000 10,795,000 Long term borrowings 54,000 -- 5,000 -- -- Stockholders' equity 4,149,000 6,299,000 4,510,000 7,809,000 7,862,000
NOTES TO SELECTED FINANCIAL DATA (1) Effective March 10, 1997, an 18 for 1 stock split was declared resulting in 3,484,260 shares being then outstanding. On December 1, 1997, NetLojix effected a one for four reverse stock split as part of its reincorporation in Delaware, and then acquired Matrix Telecom through the issuance of 9,582,493 shares of Common Stock (including 1,999,997 shares held as treasury stock after the share exchange which have subsequently been cancelled). All share amounts have been restated to reflect the stock splits and share exchanges. (2) Per share amounts are not reflected for 1996 due to the recapitalization of NetLojix as a result of the reverse acquisition in 1997. (3) All amounts have been restated to give effect to the discontinued operations treatment of the residential long distance business. 23 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in connection with the consolidated financial statements and the accompanying footnotes included later in this Form 10-K. This discussion includes "forward-looking" statements which are based on current expectations and judgments of management, which involve risks and uncertainties. There are risks that what we expect may not happen in the future. Because of these risks and uncertainties, what happens in the future may be very different from what we contemplate in our forward-looking statements. BACKGROUND DESCRIPTION OF OUR REVENUE SEGMENTS We classify our business into three segments: network connectivity, technical support and application development and hosting. The segmentation of our company is how we manage the day-to-day operations of our business and is based on the types of services we provide. All of our services are targeted toward small to mid-sized businesses. NETWORK CONNECTIVITY The network connectivity segment includes services provided to our customers that are connections for the transfer of data or voice traffic. We provide numerous Internet service options, data and voice access and traditional long distance services. Our Internet product offerings within the network connectivity segment include dial-up access, DSL, dedicated access and cable access. Our telecommunications product offerings include dedicated or leased lines, switched long distance, frame relay, ATM, calling cards, and "1-800" services. This segment includes the Internet connectivity portion of our Internet service provider business. Within this segment, our networking and communications professionals will design, build and maintain a flexible, cost-effective package of data networking and voice communication services to meet our customer's needs. TECHNICAL SUPPORT Technical support services encompasses a broad array of solutions including system integration, desktop and network support, asset management and help desk solutions aimed at keeping our customers' IT systems operational and their networks running smoothly. The IT support team is certified by over 40 hardware and software manufacturers. Service options 24 within this segment include systems and network installations, flat-fee maintenance contracts, prepaid time block retainers, help desk management contracts, warranty repairs and a small amount of hardware sales. APPLICATION DEVELOPMENT AND HOSTING The applications development and hosting services segment includes producing, designing, and programming creative multimedia and commerce applications that can be produced as a web application or a stand alone application. Once a web site has been designed we can also provide site maintenance services, host the web site on our own web servers or provide co-location space within one of our data centers. FINANCIAL INFORMATION PRESENTATION As described previously, (see "Business -- Background -- Acquisition of Matrix Telecom") on December 1, 1997, we acquired Matrix Telecom through a share for share exchange of common stock. (the "Share Exchange"). For accounting purposes, the Share Exchange was treated as a reverse acquisition of NetLojix by Matrix Telecom. Even though we were the legal acquirer, the historical financial statements were required to be prepared as if Matrix Telecom acquired NetLojix. Consequently, the following discussion of results of operations reflects the operations of Matrix Telecom prior to December 1, 1997 and reflects the combined operations of NetLojix and Matrix Telecom subsequent to December 1, 1997. References to "the Company" or "our" financial statements and financial information refer to operations of Matrix Telecom prior to the Share Exchange and the combined operations of Matrix Telecom and NetLojix subsequent to the Share Exchange. The reverse acquisition of NetLojix by Matrix Telecom was accounted for using the purchase method of accounting. In order to value the consideration given in the Share Exchange, the market price of NetLojix's Common Stock for a period immediately preceding the announcement of the Share Exchange was used. As of the date of acquisition, we determined the fair value of the net tangible and intangible assets and liabilities acquired. The underlying fair value of our net assets was substantially less than the indicated market value of our common and preferred stock. Accordingly, we recorded a charge to income of $9.1 million immediately subsequent to the reverse acquisition. In August, 1999 we decided to exit the residential long distance business and focus exclusively on business customers. As of August, 1999 Matrix Telecom was engaged in the residential long distance telephone business and represented all of the Company's business in this segment. Consequently, effective with the execution of a definitive agreement (the measurement date), the residential long distance operations of Matrix Telecom have been reflected as a discontinued operation in the consolidated financial statements. All prior year financial information has been restated to conform to the discontinued operations presentation. On November 30, 1999, we sold all of the stock of Matrix Telecom to Matrix Acquisition 25 Holdings Corp., a wholly-owned subsidiary of Platinum Equity Holdings, LLC, and recorded a gain of $5.8 million. The purchase price for the Matrix Telecom stock was valued at $6.1 million and consisted of four components. First, we received a credit against future charges incurred for long distance wholesale telephone traffic pursuant to our service contract with Matrix Telecom. We calculated the amount of this credit to be $0.6 million. Second, we eliminated $4.2 million in intercompany indebtedness owed to Matrix Telecom by NetLojix. Third, we retained federal income tax refunds paid to or due Matrix Telecom in the total amount of $1.2 million. Fourth, we were to receive a possible cash payment based upon Matrix Telecom's Internet service customer base. In addition, we received an indemnity from Platinum against certain claims or liabilities arising under NetLojix's secured credit facility with Coast Business Credit. NetLojix also has been released by Coast Business Credit from any claims or liabilities relating to borrowings secured by the assets of Matrix Telecom. The amount of the final purchase price is subject to adjustment based on finalization of a balance sheet for Matrix Telecom as of August 31, 1999 and agreement by both parties. We completed the balance sheet and we were notified by Platinum that they materially disagreed with the closing balance sheet that we prepared. We attempted to negotiate a settlement of the balance sheet items in disagreement, but were unsuccessful. To date, the buyer has resisted submitting the matter to an independent firm of accountants chosen by the parties for final resolution, as required by the contract. At this time, we believe that the ultimate resolution of the items in dispute will not materially effect the recorded gain. On August 29, 2000, we acquired Smith Technology Solutions, Inc. ("STS"), a privately-held California corporation based in Pleasanton, California, in exchange for 250,000 shares of common stock and $150,000 in cash. On September 22, 2000, we acquired CW Electronic Enterprises, Inc. ("CWE(2)"), a privately-held Illinois corporation based in Arlington Heights, Illinois, in exchange for 500,000 shares of common stock and $150,000 in cash. Both companies provide local and wide area network design, integration and web-site design and management for mid-size businesses. The acquisitions were accounted for as purchases and, consequently the results of operations of STS and CWE(2) are included in results of operations in the technical support segment since the date of the acquisitions. RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2000 COMPARED WITH YEAR ENDED DECEMBER 31, 1999 REVENUES Revenues from continuing operations increased $3.8 million or 22.8% to $20.7 million for the year ended December 31, 2000 as compared to $16.9 million for 1999. Approximately $0.6 million of the increase is attributable to acquisitions that were completed in 2000. In March 2000 we acquired the assets of Flash Internet, Inc. and in August and September 2000 we acquired STS and CWE(2) respectively. 26 NETWORK CONNECTIVITY SEGMENT During 2000 we derived 55.9% of our revenues from network connectivity services versus 56.8% in 1999. Segment revenues increased $2.0 million to $11.6 million for the year ended December 31, 2000 from $9.6 million for the year ended December 31, 1999. Within the network connectivity segment, data and voice services accounted for $1.66 million of the increase with the balance of the increase attributable to Internet services. Data and voice services revenue increased 26.1% in 2000 over 1999 as the Company significantly expanded its sales of dedicated connectivity services during 2000. The increase was attributable to an increase in billable revenue minutes to approximately 92 million minutes from 75.6 million minutes, a 22% increase. The increase in call traffic was partially offset by a decline in billing rates per minute. Our average rate per minute during 2000 was 5.8 cents compared to 8.31 cents per minute in 1999 or a 30% decline. The decrease in per minute rates is attributable to continued competitive pricing pressures within the telecommunications industry. We believe that the downward competitive pressure on long distance rates will continue to adversely effect our revenues and gross margins for our traditional long distance products. Internet connectivity services revenues increased 10.8% to $3.6 million. Demand for Internet connectivity in the central California area continues to grow. The increase in revenues is attributable to broadband Internet access products which include frame relay, cable, ISDN and DSL. We believe that while demand for broadband Internet access products will continue to be strong, there will be downward competitive pricing. We have upgraded our product offerings through partnerships and alliances with major vendors so that we can continue to increase our focus on broadband products. TECHNICAL SUPPORT SERVICES SEGMENT Technical support services revenues were $6.5 million for the year ended December 31, 2000 compared to $5.3 million in 1999. Approximately $0.6 million of the increase was due to the acquisition of CWE(2) and STS late in the third quarter. The balance of the increase was due to increased revenues from the cross marketing of technical support services to network connectivity customers and increased sales of our help desk solution, including a fourth quarter sale to Black & Decker. APPLICATION DEVELOPMENT AND HOSTING SEGMENT Application development and hosting segment revenues increased to $2.6 million for the year ended December 31, 2000 from $2.0 million for the year ended December 31, 1999. The $0.6 million increase is primarily attributable to a strategic decision to focus our applications development efforts on e-commerce, web centric applications and managed web hosting which made up approximately 63% of our current period revenues. Generally, these services are higher margin services. We expect to increase our focus on web centric applications and an expanded portfolio of managed hosting services. In the fourth quarter, the Company initiated the expansion 27 of its Santa Barbara data center to support its increased service offerings. During 1999, a high percentage of our applications development work was centered on CD-ROM based media, which we are no longer pursuing. GROSS MARGIN Gross margin on continuing operations as a percentage of revenues decreased to 39.4% for the year ended December 31, 2000 from 44.4% for the year ended December 31, 1999. Total gross profit was $8.2 million for the year ended December 31, 2000 compared with $7.5 million for 1999. NETWORK CONNECTIVITY SEGMENT The network connectivity segment recorded a gross margin of 33.5% during 2000 compared to a gross margin 45.0% for the year ended December 31, 1999. The decrease in gross margin was attributable to a decrease in the gross margins on primarily our voice and data products. Data and voice gross margins averaged 17% during 2000 compared with 25.7% in 1999. The decline in data and voice gross margin was primarily due to the renegotiation of certain large customer contracts reducing their long distance rates in response to competitive pressures Gross margins for Internet services continue to be strong averaging 70% during 2000 compared with 81.8% for 1999. The decrease from 1999 is primarily attributable to increased network costs relating to high-speed connectivity. We have increased capacity for these services and are currently able to increase customers with minimal additional network costs. TECHNICAL SUPPORT SEGMENT Technical support services gross margins averaged 39.0% during the year ended December 31, 2000 compared with 36.0% during 1999. Gross margins in the technical service segment were improved as our management of technical resource allocation and productivity increased. We were also able to raise certain retail pricing as demand for IT professional services increased. However, salary expense for high demand technicians will likely continue to increase and put downward pressure on margins. While we may be able to increase retail pricing to offset salary increases, competitive pressures may require us to absorb some of the additional costs. APPLICATION DEVELOPMENT AND HOSTING SEGMENT Application development and hosting gross margins were 66.9% during 2000 compared with 63.2% for 1999. The increase in gross margin is due primarily to increased emphasis on web hosting, e-commerce and web development solutions which are higher margin products. 28 SELLING, GENERAL, AND ADMINISTRATIVE COSTS Selling, general, and administrative costs from continuing operations increased $1.1 million to $12.4 million for the year ended December 31, 2000 from $11.3 million for the year ended December 31, 1999. As a percentage of revenues, selling, general and administrative costs decreased to 60% for year ended December 31, 2000 from 67.3% for 1999. Of the increase in selling, general and administrative expenses, approximately $0.5 million of the increase, or nearly 50%, is attributable to the acquisitions of STS and CWE(2) which were completed late in 2000. Approximately $0.2 million is attributable to the non-cash expense associated with warrants issued to the Company's investment banker for advisory services. Approximately $0.1 million of the increase is attributable to severance costs. In January 2000, the Company relocated its finance and accounting function to Santa Barbara and paid severance to employees that declined to relocate. The remaining increase in cost was associated with increased professional fees and costs related to expanding the sales force and related expenses including general office expense, rent, utilities and travel expenditures. In November 2000, the Company implemented a cost reduction plan in an effort to reduce operating expenses. This plan included a 19% reduction in staff along with a consolidation of office space and a streamlining of the Company's business units. DEPRECIATION AND AMORTIZATION Depreciation and amortization increased $0.2 million to $1.2 million for the year ended December 31, 2000 from $1.0 million for the year ended December 31, 1999. The increase was primarily due to increased amortization and depreciation related to the purchase of STS and CWE(2) late in the third quarter of 2000. At December 31, 2000, the Company determined that approximately $298,000 of its goodwill was impaired, and this amount has been written off. SETTLEMENT COSTS On April 19, 2000, the Company reached an agreement in principle to settle all outstanding claims under the class action lawsuit pending against NetLojix and certain of its officers. The agreement between the Company and the plaintiff class was finalized on October 4, 2000. This agreement received the preliminary approval of the court on November 8, 2000, but remains subject to passage of a class member notification period, a settlement hearing and the entry of a final order by the court. Under the terms of the settlement, the Company will issue 232,000 shares of common stock and warrants to purchase 200,000 shares of the Company's common stock at an exercise price of $8.00 per share with a term of 2 years. As a result of the preliminary court approval, NetLojix has paid $150,000 in administrative costs and other expenses in accordance with the settlement agreement. In March 2000, the Company estimated the expense and recorded a charge against earnings of $998,000 and a liability relating to the expected settlement. Upon final settlement and issuance of the shares and warrants, the expense will be adjusted based on the stock price at that time. INTEREST EXPENSE The Company currently has $1.2 million outstanding under its secured line of credit. For 29 the twelve months ended December 31, 2000 the Company averaged approximately $0.6 million in outstanding borrowings. YEAR ENDED DECEMBER 31, 1999 COMPARED WITH YEAR ENDED DECEMBER 31, 1998 REVENUES Revenues from continuing operations increased $7.0 million or 70.6% to $16.9 million for the year ended December 31, 1999 as compared to $9.9 million for 1998. Approximately $5.4 million of the increase is attributable to acquisitions that were completed late in 1998. In September 1998 we acquired DMI and in November 1998 we acquired Remote Lojix. The acquisitions contributed a full year of operations in 1999 compared with a partial year in 1998. We did not complete any acquisitions during 1999 as we concentrated our efforts on integrating our 1998 acquisitions. As a result, we anticipate revenue growth to come solely from organic or internal expansion of our business segments and future acquisitions. NETWORK CONNECTIVITY SEGMENT During 1999 we derived 56.8% of our revenues from network connectivity services versus 80.9% in 1998. Segment revenues increased $1.6 million to $9.6 million for the year ended December 31, 1999 from $8.0 million for the year ended December 31, 1998. Within the network connectivity segment, data and voice services accounted for $1.2 million of the increase with the balance of the increase attributable to Internet services. Data and voice services revenue increased 24.5% in 1999 over 1998 as the Company significantly expanded its sales force during 1999. The increase was attributable to an increase of $0.5 million in dedicated access and an increase in billable revenue minutes to 75.6 million minutes from 50.6 million minutes, a 49.3% increase. The increase in call traffic was partially offset by a decline in billing rates per minute. Our average rate per minute during 1999 was 8.31 cents compared to 9.98 cents per minute in 1998 or a 16.7% decline. The decrease in per minute rates is attributable to continued competitive pricing pressures within the telecommunications industry. We believe that the downward competitive pressure on long distance rates will continue to adversely effect our revenues and gross margins for our traditional long distance products. Internet connectivity services revenues increased 11.6% to $3.3 million. Demand for Internet connectivity in the central California area continues to be strong with customer attrition rates running below industry averages at about 1.5% per month. The increase in revenues is attributable to dedicated Internet access products which include frame relay, cable, ISDN and DSL. Our dedicated Internet access customer base increased over 350% in 1999 as compared to 1998. We believe that demand for broadband Internet access products will continue to be strong. We have upgraded our product offerings through partnerships and alliances with major vendors so that we can continue to increase our focus on broadband products. 30 TECHNICAL SUPPORT SERVICES SEGMENT Technical support services revenues were $5.3 million for the year ended December 31, 1999 compared to $1.0 million in 1998. In November, 1998 we acquired Remote Lojix which started our technical support services. Therefore the 1998 results represent two months of operating activity as opposed to 12 months in 1999. APPLICATION DEVELOPMENT AND HOSTING SEGMENT Application development and hosting segment revenues increased to $2.0 million for the year ended December 31, 1999 from $0.9 million for the year ended December 31, 1998. During 1998 we recorded a $119,000 management fee relating to the acquisition of DMI. Excluding the one time management fee, revenues for this segment grew by $1.2 million or over 150%. The increase is primarily attributable to applications services that were acquired in the DMI acquisition in September 1998. GROSS MARGIN Gross margin on continuing operations as a percentage of revenues increased to 44.4% for the year ended December 31, 1999 from 42.7% for the year ended December 31, 1998. Total gross profit was $7.5 million for the year ended December 31, 1999 compared with $4.2 million for 1998. The 77.3% increase is primarily attributable to the 70.6% increase in total revenues, with the balance attributable to increase in gross margin for several segments as described below. NETWORK CONNECTIVITY SEGMENT The network connectivity segment recorded a gross margin of 45.0% during 1999 compared to a gross margin 38.2% for the year ended December 31, 1998. The increase in gross margin was attributable to an increase in the gross margins on our data and voice products. Data and voice gross margins averaged 25.7% during 1999 compared with 13.2% in 1998. During 1999, the Company received a credit from its major vendor of $0.2 million relating to prior periods network service costs. Excluding the effect of the one-time credit, the Company's gross margins for data and voice services would have been 22.3%. Effective February 15, 1999, we negotiated significantly lower rates with our major underlying carrier for dedicated traffic. The improvement in gross margins was partially offset by the re-negotiation of a major customer contract which resulted in lower retail business rates. The lower rates were effective with August 1999 traffic and extend through October 2000. Gross margins for Internet services continue to be strong averaging 81.8% during 1999 compared with 81.2% for 1998. 31 TECHNICAL SUPPORT SEGMENT Technical support services gross margins averaged 36.0% during the year ended December 31, 1999 compared with 39.5% during 1998. During 1999 salaries expense for technical service employees increased which adversely effected margins. We expect margins will continue to be under pressure as the projected demand for IT professionals is expected to outweigh the supply. We are anticipating increasing retail prices in response to the increased demand for IT professionals. APPLICATION DEVELOPMENT AND HOSTING SEGMENT Application development and hosting gross margins were 63.2% during 1999 compared with 86.5% for 1998. The decrease in gross margin is due to the $119,000 management fee relating to the acquisition of DMI recorded in 1998 and the increase in applications development projects within this segment. Gross margins for applications development projects are negotiated on a project by project basis and tend to fluctuate for each project depending on the total dollar amount, deadline commitments and specialized expertise that may be required for a particular project. Total gross profit increased to $1.3 million from $.8 million in 1998. SELLING, GENERAL, AND ADMINISTRATIVE COSTS Selling, general, and administrative costs from continuing operations increased $4.2 million to $11.3 million for the year ended December 31, 1999 from $7.1 million for the year ended December 31, 1998. Approximately $2.3 million of the increase is attributable to the acquisitions of DMI and Remote Lojix which were completed late in 1998. The acquisitions contributed a full year of operations in 1999 compared with a partial year in 1998. As a percentage of revenues, selling, general and administrative costs decreased to 67.3% for year ended December 31, 1999 from 71.6% for 1998. Approximately $0.6 million of the increase is due to increased legal and professional fees, primarily due to the class action lawsuit. The remaining increase in selling, general and administrative costs was associated with expanded sales force and related expenses including salaries, general office expense, rent, utilities and travel expenditures. DEPRECIATION AND AMORTIZATION Depreciation and amortization increased $0.4 million to $1.0 million for the year ended December 31, 1999 from $0.6 million for the year ended December 31, 1998. The increase was primarily due to increased goodwill amortization related to the purchase of Remote Lojix during the fourth quarter of 1998. DISCONTINUED OPERATIONS As noted earlier, in August, 1999 we decided to exit the residential long distance business and focus exclusively on business customers. Consequently, effective with the execution of a definitive agreement, the residential long distance operations of Matrix Telecom have been 32 reflected as a discontinued operation in the Company's consolidated financial statements. All historical years have been restated to conform to the discontinued operations presentation. Loss from operations of our discontinued residential long distance business was $3.0 million for the year ended December 31, 1999 compared with a loss of $2.5 million 1998. The 1998 loss included a tax benefit of $1.4 million. The tax benefit resulted from the loss from discontinued operations and the carry back of a portion such loss to prior years. In accordance with APB 30, since September 1, 1999, all losses of Matrix Telecom were deferred and were recognized as a reduction of the gain on the sale. LIQUIDITY AND CAPITAL RESOURCES For the year ended December 31, 2000, NetLojix reported a net loss from continuing operations of $6.9 million and net cash used in operations of $3.4 million. As of December 31, 2000, NetLojix had cash and cash equivalents of $0.2 million and an outstanding indebtedness on its line of credit of $1.2 million. At that date, we had a working capital deficit of $3.8 million. In their report on NetLojix's December 31, 2000 consolidated financial statements, our independent auditors have included an explanatory paragraph indicating that NetLojix's recurring operating losses and working capital deficit at December 31, 2000 raise doubts in their minds about NetLojix's ability to continue as a going concern. As described in more detail below, we took steps in late 2000 to improve our cash flow from operations. These steps included a reduction in staff, closure of offices and a refocusing of our marketing and sales activities on more profitable lines of business. In May 2000, we amended our secured credit facility with Coast Business Credit. Under the amended line of credit, we may borrow up to 75% of eligible receivables (as defined) up to a total amount of $3.0 million. The percentage may be increased to 80% of eligible receivables if we reach certain operational targets. In addition, the line of credit may be used to provide a facility for issuing letters of credit. Borrowings under the line of credit bear interest, payable monthly, based upon the prime rate of Bank of America NT & SA plus 2% (10.0% at March 28, 2001). Borrowings under the credit facility are secured by substantially all of our assets. As of March 21, 2001, approximately $1.2 million is outstanding under the credit facility, and approximately $0.2 million is available to be borrowed under the formula described above. On April 23, 1999, we entered into an equity line agreement with Cambois Finance, Inc. Under the terms of the equity line agreement, we may sell or put our common stock to Cambois Finance, at our option at any time, subject to the satisfaction of several conditions. The equity 33 line agreement provides for Cambois Finance to purchase up to $13,500,000 of our common stock, subject to our filing and maintaining an effective registration statement, trading price and volume minimums, and limits on the amount and frequency on sales of common stock under the line. To date, we have sold an aggregate of 1,066,725 shares of common stock to Cambois Finance for total proceeds of $2,000,000. Our stock must have a minimum bid price of $2.26 per share in order for us to require Cambois Finance to purchase stock, unless Cambois Finance otherwise agrees. Because our current trading price is below this level, we are unable to utilize the equity line without Cambois's agreement. We have not sold any shares of common stock to Cambois under the equity line agreement since December 1999. On March 3, 2000 we raised $1.5 million through a private placement of 375,000 shares of common stock at $4.00 per share. We also issued the private investor warrants to purchase up to 75,000 shares of common stock at a price of $5.25 per share. The warrants are exercisable beginning September 1, 2000 and ending March 1, 2003. During the year ended December 31, 2000, NetLojix received proceeds of $1.2 million relating to stock option exercises. The option exercises were primarily attributable to stock options granted by the Company in 1997 under the New Best Connections, Inc. Amended and Restated 1997 Option Plan. Under the plan, NetLojix issued stock options to purchase 1,292,000 shares of common stock at $1.50 per share to certain distributors and agents of Matrix Telecom, Inc. The options were originally granted to facilitate the marketing of residential long distance services. Pursuant to the terms of the option grant, the options became fully vested upon the sale of Matrix Telecom, Inc. and expired on May 22, 2000. NetLojix recorded commission expense over the vesting period of the option grant totaling $762,000. As a consequence of the May 22, 2000 expiration date, 713,000 options were exercised during the year ended December 31, 2000. On February 21, 2001, we paid $120,000 in connection with the settlement agreement entered into in November 2000 with respect to NetLojix's outstanding class action lawsuit. Historically, our cash flow from operations, our secured borrowings, our private placements of both common and preferred stock and our equity line agreement with Cambois Finance, Inc. have been sufficient to meet working capital and capital expenditure requirements. However, as noted above, we currently cannot utilize the equity line without the agreement of Cambois. We believe that current public market conditions are not conducive to raising large amounts of additional capital at this time. Therefore, we have taken several steps to conserve cash and reduce operating expenses. These steps include the termination of 30 employees, which was effected on November 9, 2000. After giving effect to the cost control measures, we expect that operating cash flows coupled with the remaining availability under our secured line of credit facility should be sufficient to meet our minimum working capital requirements into the foreseeable future. While we believe the cost control measures will significantly reduce our monthly cash requirements, we are also exploring other possible sources of cash including the possibility of a private equity placement. However, our current low stock price and possible 34 delisting from The Nasdaq SmallCap Market present substantial obstacles to additional private placements. Additionally, an important component of our past growth has been to develop our business through acquisitions. During the year ended December 31, 2000, we completed acquisitions through the issuance of an aggregate of 805,000 shares of common stock and the payment of $325,000 in cash. In appropriate circumstances, we may use our capital stock for additional acquisitions in addition to debt and equity financing. However, our current low stock price again presents a substantial obstacle to such acquisitions. INFLATION We do not believe that the relatively moderate rates of inflation over the past three years have had a significant effect on our net sales or our profitability. RECENTLY-ISSUED ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance for revenue recognition under various circumstances. The accounting and disclosures prescribed by SAB 101 became effective for the fourth quarter of NetLojix's fiscal year ended December 31, 2000. Complying with SAB 101 did not require any change in NetLojix's revenue recognition policies and did not effect the NetLojix's financial position or results of operations. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We have not been exposed to material future earnings or cash flow fluctuations from changes in interest rates on our credit facility at December 31, 2000. A hypothetical increase of 100 basis points in interest rate (ten percent of our overall borrowing rate) would not result in a material fluctuation in future earnings or cash flow. We have not entered into any derivative financial instruments to manage interest rate risk or for speculative purposes and we are not currently evaluating the future use of such financial instruments. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements of NetLojix and supplementary data are included beginning immediately 35 following the signature page to this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE By unanimous written consent, effective June 16, 2000, the Board of Directors of NetLojix, upon recommendation of the Audit Committee of the Board of Directors, approved the dismissal of KPMG LLP as independent auditors for NetLojix. The audit reports of KPMG LLP on NetLojix's consolidated financial statements as of and for the years ended December 31, 1999 and 1998 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles. In connection with the audits of NetLojix's consolidated financial statements for the two fiscal years ended December 31, 1999, and the subsequent interim period preceding the dismissal, there were no disagreements with KPMG LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of KPMG LLP would have caused KPMG LLP to make reference to the subject matter of the disagreements in connection with their report. KPMG LLP furnished NetLojix with a letter addressed to the Securities and Exchange Commission stating that it agrees with the above statements. A copy of that letter, dated June 19, 2000, has been filed with the Commission by NetLojix. On June 16, 2000, NetLojix engaged Ernst & Young LLP, certified public accountants, as independent auditors for NetLojix for 2000. The engagement of Ernst & Young LLP was approved by unanimous written consent of the Board of Directors of NetLojix, upon recommendation of the Audit Committee of the Board of Directors. During the two fiscal years ended December 31, 1999, and the subsequent interim period preceding this engagement, neither NetLojix nor anyone acting on its behalf consulted Ernst & Young LLP regarding the application of accounting principles to a specified transaction, either completed or proposed; the type of audit opinion that might be rendered on NetLojix's financial statements; or any disagreement with, or reportable event relating to, KPMG LLP. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS There are currently four members of our Board of Directors, and one vacancy. The Board is currently reviewing possible candidates for director, and expects to fill the vacancy with an independent director prior to June 2001. Information with respect to the existing directors is set forth below. 36 ANTHONY E. PAPA, age 38, has been the Chairman of the Board and Chief Executive Officer of NetLojix since October 1996. Mr. Papa was also President of NetLojix from October 1996 until February 1998. Prior to October 1996, Mr. Papa had served as President of ICS Communications, Inc., Richardson, Texas, a national provider of cable television, wireless paging, local and long distance telephone services from December 1992. Before joining ICS Communications, Mr. Papa served as general manager for Spectradyne, Inc., the largest provider of pay-per-view entertainment and interactive services to the hospitality industry. Mr. Papa is a director of ABC-Clio, Inc., an international publisher of historical reference materials for institutions of higher education. Mr. Papa received a B.S. in Management from Iona College, in New Rochelle, New York. JAMES P. PISANI, age 36, has been the President of NetLojix since February 1998, and has served as Chief Operating Officer and Secretary of NetLojix since October 1996. From October 1996 to May 1999, Mr. Pisani was the Chief Financial Offer of NetLojix. Mr. Pisani also served as Chief Accounting Officer of NetLojix from October 1998 until May 3, 1999 From October 1996 to February 1998, Mr. Pisani was the Executive Vice President of NetLojix. Prior to October 1996, he served as Vice President of Sales and National Accounts for ICS Communications. While at ICS, Mr. Pisani was responsible for that firm's business-to-business and consumer sales activities. Mr. Pisani graduated from Princeton University in 1986, with a degree in Economics. JEFFREY J. JENSEN, age 42, has been a director of NetLojix since January 1998. He has been the President of Specialized Association Services, Ltd., which provides marketing and administrative services to regional and national trade associations, for more than five years. Between 1996 and July 1998, Specialized Association Services was known as CORE Marketing, Inc. and provided direct mail and telemarketing facilities in addition to its other activities. Mr. Jensen has also been the President of United Group Service Centers, Inc., an employee leasing company, since January 2000, and prior to that was its Vice President for more than five years. Mr. Jensen is a Trustee of Amli Commercial Properties Trust, a real estate investment trust, and RMH Teleservices, Inc. (Nasdaq: RMHT), a provider of outsourced customer relationship management. He also holds equity interests in several Internet and technology companies. Mr. Jensen received B.A. degrees in Economics and Philosophy from Cornell College, in Mount Vernon, Iowa and holds an M.S. in Information Systems from the University of Texas at Arlington. ANTHONY D. MARTIN, age 51, has been a director of the Company since April 1999. Mr. Martin was the President and Chief Operating Officer of PF.Net Communications, Inc., a facilities-based provider of high capacity fiber optic network and infrastructure and communications services, from March 2000 to December 2000. Mr. Martin was Managing Director of CrossHill Financial Group Inc., from March 1998 to April 2000. From January 1997 through July 1997, he served as President and CEO of Nexus Communications, Inc., a start-up company providing information services. From January 1994 to December 1996, he served as Vice President, Business Development of MCI Metro, MCI Telecommunications, Inc.'s local service initiative. Prior to that, he held several senior management positions at MCI, including 37 Vice President, Access Services Project Management; Vice President, Systems Engineering and Support Operations; Vice President, Carrier Marketing and Alliances; Vice President, Finance Administration; and Vice President, Technical Planning. He received a B.S. from the United States Naval Academy and an M.B.A. from the University of Detroit. EXECUTIVE OFFICERS Set forth below is information with respect to each executive officer of NetLojix, other than Messrs. Papa and Pisani. Information with respect to Messrs. Papa and Pisani is set forth above under "Directors." MATTHEW A. BLUMENTHAL, age 30, has been Vice President Sales & Field Service of NetLojix since July 7, 2000. From August 1999 to July 2000, Mr. Blumenthal served as Director of Alternate Channels and Regional Vice President of the Northeast Region for NetLojix. From December 1998 until May 1999, he was Northeast Director of Sales for NetLojix . Between May 1999 and August 1999, he was employed as the Vice President of Sales for CareerEngine Network, Inc. From August 1996 to November 1998, he was employed as Vice President of Sales by Remote Lojix/PCSI, Inc, which was acquired by NetLojix in November 1998. Mr. Blumenthal has a B.A. from Gettysburg College. CRAIG R. CLARK, age 51, has been Vice President, Business Development of NetLojix since April 1999. He also served as the Interim Chief Financial Officer of NetLojix in December 2000. Mr. Clark served as a consultant to NetLojix from May 1998 until NetLojix employed him in April 1999. From March 1997 to May 1998 Mr. Clark was a self-employed financial consultant. From June 1994 to March 1997 Mr. Clark served as the Executive Vice President and Chief Financial Officer of Unison HealthCare Corporation ("Unison") and its predecessors. In May 1998 Unison filed for reorganization under Chapter 11 of the Bankruptcy Code. Mr. Clark, without admitting or denying the allegations, has offered to settle a civil action brought by the Securities and Exchange Commission (the "Commission") alleging that he violated certain federal securities laws in connection with Unison's September 30, 1996 quarterly report on Form 10Q. Pursuant to the settlement offer, Mr. Clark would consent to the entry of an order enjoining him from future violations of securities laws and directing payment of a $15,000 penalty, and of an order under the Commission's Rules of Practice denying him the privilege of appearing or practicing before the Commission for three years. From 1972 to 1989 Mr. Clark was associated with Arthur Young & Company, most recently as a partner. Mr. Clark has a B.S.B.A. from Washington University in St. Louis, Missouri, and an M.B.A. from the University of California, Los Angeles. JOE RENTERIA, JR., age 53, was appointed Vice President, Information Systems of NetLojix in February 1999. Prior to that time, he had been employed for more than five years by Matrix Telecom, Inc., which was became a subsidiary of NetLojix in December 1997. During his tenure with Matrix Telecom, Mr. Renteria served as Manager of Data Processing, Director of Information Services and was promoted to Vice President of Information Services in May of 1997. Prior to joining Matrix Telecom, Mr. Renteria held various information technology management positions, primarily in the manufacturing sector. GREGORY J. WILSON, age 34, has been Treasurer of NetLojix since March 1, 2001. He has 38 served as Controller of NetLojix since January 1, 2001, and prior to that he had served as Assistant Controller of NetLojix since January 2000. From January 1994 to January 2000, Mr. Wilson was the Accounting Manager for Imperial Credit Industries, Inc., a financial services holding company. Mr. Wilson received a B.S. and an M.B.A. from the California Polytechnic University, San Luis Obispo. There are no family relationships between any directors or executive officers of NetLojix. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires NetLojix's officers and directors, and persons who own more than ten percent of a registered class of NetLojix's equity securities to file reports of ownership and changes in ownership with the SEC. Officers, directors and greater than ten-percent shareholders are required by SEC regulation to furnish NetLojix with copies of all Section 16(a) forms they file. During the year ended December 31, 2000, Mr. Blumenthal failed to file a Form 3 on a timely basis after becoming an executive officer of NetLojix. This form, which reported only Mr. Blumenthal's initial holdings at the time of his elevation to executive officer status, was filed approximately one week late. Based solely on a review of the copies of Section 16(a) forms furnished to NetLojix, and on written representations that no Forms 5 were required, NetLojix believes that during 2000 no other officer, director or greater than ten-percent shareholder failed to file on a timely basis any report required under Section 16(a). ITEM 11. EXECUTIVE COMPENSATION The following table summarizes all compensation for the fiscal year ended December 31, 2000 paid to the Company's Chief Executive Officer, the four other most highly compensated executive officers of the Company who were serving as executive as executive officers on December 31, 2000 and one individuals that ceased to be an executive officer during such fiscal year (the "Named Executive Officers"). Titles shown are those held by the Named Executive Officers at December 31, 2000, or, in the case of the individual that is no longer an executive officer, on the date he ceased to be an executive officer. 39 SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION AWARDS NAME AND OTHER ANNUAL PRINCIPAL FISCAL COMPENSATION SECURITIES UNDERLYING ALL OTHER POSITION YEAR SALARY BONUS ($) OPTIONS (#) COMPENSATION(1) -------- ------ ------ ----- --- ----------- --------------- Anthony E. Papa 2000 $252,513 $25,000 (2) -- 100,000 $5,250 Chairman and Chief 1999 237,187 25,000 -- 100,000 5,000 Executive Officer 1998 198,000 50,000 -- -- -- James P. Pisani 2000 $229,558 $25,000 (2) -- 100,000 $1,406 President, Chief 1999 215,625 25,000 -- 100,000 1,350 Operating Officer and 1998 180,000 50,000 -- -- -- Secretary Matthew A. Blumenthal(3) 2000 $110,422 $20,288 $55,071 (4) 145,000 $4,748 Vice President Sales & 1999 97,550 -- $56,038 (4) 10,000 3,540 Field Service 1998 120,000 -- -- 10,000 -- Craig R. Clark (5) 2000 $148,077 $78,389 (6) -- 50,000 -- Vice President, 1999 112,500 74,500 (6) -- 100,000 -- Business Development, 1998 -- -- -- -- -- Interim Chief Financial Officer Frank A. Leone (7) 2000 $175,577 $33,656 -- 25,000 $4,125 Executive Vice 1999 165,000 -- $78,622 (4) -- 4,785 President of Field 1998 27,000 -- -- 150,000 -- Sales and Service Joseph Renteria, Jr. 2000 $122,564 $51,754 -- 25,000 $4,569 Vice President, 1999 117,559 50,000 -- 5,000 3,460 Information Systems 1998 102,504 -- -- 20,000 --
------------------- (1) Represents company contribution to defined contribution plan. (2) Retention bonus paid in January 2000. (3) Became employed by the Company on November 19, 1998. Was not employed by NetLojix during a portion of 1999. Mr. Blumenthal became Vice President of Sales and Field Service on July 7, 2000. (4) Consists of sales commissions paid. (5) Became employed by the Company on April 1, 1999. Mr. Clark became Interim Chief Financial Officer on December 4, 2000. (6) Includes special bonuses paid upon completion of acquisition transactions. (7) Became employed by the Company on November 2, 1998. Mr. Leone ceased to be employed by the Company on September 30, 2000. His options have expired upon the termination of his employment. 40 The following table summarizes all option grants to the Named Executive Officers during the year ended December 31, 2000. No stock appreciation rights were awarded during such year.
OPTION GRANTS IN LAST FISCAL YEAR (Individual Grants) NUMBER OF PERCENT OF SECURITIES TOTAL OPTIONS POTENTIAL REALIZABLE VALUE AT UNDERLYING GRANTED TO ASSUMED ANNUAL RATES OF STOCK OPTIONS EMPLOYEES IN EXERCISE PRICE APPRECIATION FOR OPTION NAME GRANTED (2) FISCAL YEAR PRICE EXPIRATION DATE TERM (1) ---- ----------- ----------- ----- --------------- -------- 0% 5% 10% -- -- --- Anthony E. Papa 100,000 6.62% $3.28 January 10, $0 $206,277 $522,748 2010 James P. Pisani 100,000 6.62% $3.28 January 10, $0 $206,277 $522,748 2010 Matthew A. 30,000 1.99% $3.28 January 10, $0 $61,883 $156,824 Blumenthal 2010 100,000 6.62% $2.78 July 7, 2010 $0 $174,833 $443,060 15,000 0.99% $0.25 December 21, $0 $2,358 $5,977 2010 Craig R. Clark 50,000 3.31% $3.28 January 10, $0 $103,139 $261,374 2010 Frank A. Leone 25,000 1.66% $3.28 January 10, $0 $51,569 $130,687 2010 Joseph Renteria, Jr. 25,000 1.66% $3.28 January 10, $0 $51,569 $130,687 2010
-------------- (1) The potential realizable value portion of the foregoing table illustrates value that might be realized upon exercise of options immediately prior to the expiration of their term, assuming (for illustrative purposes only) the specified compounded rates of appreciation of the price of the Common Stock over the term of the respective option. These amounts represent certain assumed rates of appreciation in the value of the Common Stock from the fair market value on the date of grant. The 5% and 10% assumed annual rates of compounded stock price appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent NetLojix's estimate or projection of its future Common Stock prices. These numbers do not take into account provisions providing for the termination of the option following termination of employment, nontransferability or difference in vesting terms. (2) Options vest in annual increments of 25% over the four years after the grant date. The following table provides information with respect to the unexercised stock options held as of December 31, 2000, by the Named Executive Officers. None of the Named Executive Officers exercised stock options during the year ended December 31, 2000. 41
OPTION VALUES AT DECEMBER 31, 2000 NUMBER OF SECURITIES UNDERLYING UNEXERCISED OPTIONS AT VALUE OF UNEXERCISED IN-THE-MONEY OPTIONS DECEMBER 31, 2000 AT DECEMBER 31, 2000 (1) ----------------- ------------------------ NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ----------- ------------- ----------- ------------- Anthony E. Papa 48,438 182,812 $0 $0 James P. Pisani 48,438 182,812 $0 $0 Matthew A. Blumenthal 3,333 151,666 $0 $0 Craig R. Clark 25,000 125,000 $0 $0 Frank A. Leone (2) -- -- -- -- Joseph Renteria, Jr. 11,250 38,750 $0 $0
-------------------- (1) The closing price of the Common Stock on The Nasdaq SmallCap MarketSM on December 29, 2000 was $0.16 per share. Accordingly, none of the options held by the Named Executive Officers was in-the-money at December 31, 2000. (2) All 175,000 of Mr. Leone's options expired unexercised as a result of the termination of his employment with the Company on September 30, 2000. LONG-TERM INCENTIVE PLAN - AWARDS IN LAST FISCAL YEAR (2000 Go Plan)
NAME NUMBER OF UNITS (1) PERIOD UNTIL PAYOUT ---- --------------- ------------------- Anthony E. Papa (2) 0 -- James P. Pisani (2) 0 -- Matthew A. Blumenthal 1 Annually over 4 years (1) Craig R. Clark 1 Annually over 4 years (1) Frank A. Leone (2) 1 Annually over 4 years (1) Joseph Renteria, Jr. 1 Annually over 4 years (1)
--------------- (1) Under its 2000 Go Plan, NetLojix used a total of approximately $45,000 to repurchase 14,600 shares of its own Common Stock commencing on January 28, 2000 (the "Effective Date"). One quarter of such shares are to be sold at the prevailing market price on or about each of the first four anniversaries of the Effective Date (each a "Payout Date"). Each person who was a NetLojix employee on the Effective Date will receive a pro capita share of the proceeds received from the sale of such shares on each Payout Date if, and only if, such person remains a NetLojix employee on such Payout Date. (2) Mr. Papa and Mr. Pisani are not participants in the 2000Go Plan. Mr. Leone ceased to be eligible to participate in the 2000 Go Plan as a result of the termination of his employment. 42 DIRECTOR COMPENSATION The Company's policy is to pay each non-employee director a fee of $1,000 for each Board or committee meeting he attends in person in excess of four such meetings a year; employee directors do not receive this fee. The Company did not have more than four in-person meetings during 2000. The Company reimburses directors' reasonable expenses in connection with attendance at board and committee meetings. Directors (including non-employee directors) are also eligible to receive grants of stock options and restricted stock under the Company's 1997 Stock Incentive Plan and 1998 Stock Incentive Plan. In January 2000, each of the incumbent directors received option grants under the Company's 1998 Stock Incentive Plan. Directors Jeffrey J. Jensen and Anthony D. Martin received grants of 25,000 options each. The exercise price for these options is $3.28 per share. One-half of such options became exercisable in January 2001, and the remainder will become exercisable in January 2002. Unless exercised, the options will expire in January 2010. Directors Anthony E. Papa and James P. Pisani, who are executive officers of NetLojix each received a grant of 100,000 options. See "Option Grants in Last Fiscal Year" above AGREEMENTS WITH EXECUTIVE OFFICERS NetLojix has no employment agreements with its executive officers. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During 2000, the Compensation Committee consisted of Mr. Jensen, Mr. Martin and John E. Allen, who resigned form the Board of Directors as of December 31, 2000. None of such Compensation Committee members was or has been an officer or employee of the Company or any of its subsidiaries. Certain entities with which Mr. Jensen was affiliated received payments from the Company during 2000. See "Certain Relationships and Related Transactions." No executive officer of the Company served at any time during the year ended December 31, 2000 as a member of the Board of Directors or Compensation Committee of any entity that has one or more executive officers serving as a member of the Company's Board or Compensation Committee. 43 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth stock ownership information for (i) each person known to NetLojix to own beneficially more than five percent of the outstanding shares of NetLojix common stock (ii) each director of NetLojix, (iii) each of the Named Executive Officers, and (iv) the directors and executive officers as a group. The percentages of common stock beneficially owned are based upon 14,318,423 shares of the Common Stock outstanding as of March 28, 2001.
AMOUNT BENEFICIALLY PERCENT NAME OF BENEFICIAL OWNER OWNED OF CLASS (1) --------------------------- ----- ------------ 5% STOCKHOLDERS: Janet J. Jensen (2) 961,939 6.7% 9003 Airport Freeway Fort Worth, TX 76180 Jami J. Jensen(2) 851,738 5.9% 1933 Swede Gulch Golden, CO 80120 Julie J. Jensen(2) 851,738 5.9% Box 540, Kenwood Station 5257 River Road Bethesda, MD 20816 James J. Jensen(2) 800,000 5.6% 6304 Alexandria Circle Atlanta, GA 30326 Gladys J. Jensen(2) 731,847 5.1% c/o United Group Association, Inc. 4001 McEwen Drive, Suite 200 Dallas, TX 75244 DIRECTORS AND EXECUTIVE OFFICERS: Jeffrey J. Jensen(2)(3) 889,238 6.2% Anthony E. Papa(4) 869,212 6.0%
44
AMOUNT BENEFICIALLY PERCENT NAME OF BENEFICIAL OWNER OWNED OF CLASS (1) --------------------------- ----- ------------ James P. Pisani(4) 862,812 6.0% Craig R. Clark (6) 62,500 * Joseph Renteria, Jr. (7) 56,108 * Matthew A. Blumenthal (5) 33,477 * Frank A. Leone 37,500 * Anthony D. Martin (3) 37,500 * Gregory J. Wilson (8) 3,250 * All directors and executive officers 2,814,097 19.1% as a group (8 persons) (9)
* Represents less than 1%. (1) Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission (the "SEC"). In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of NetLojix's Common Stock subject to options held by that person that are exercisable within sixty (60) days following March 28, 2001 are deemed outstanding. However, such shares of Common Stock are not deemed outstanding for the purpose of computing the percentage ownership of any other person. Unless otherwise indicated in the footnotes to this table, each person named in the table has sole voting and sole investment power with respect to the shares set forth opposite such person's name. (2) Information is derived from a Schedule 13D filed with the SEC on December 11, 1997 and a Schedule 13D/A filed with the SEC (by Gladys J. Jensen only) on July 10, 1998 (the "Schedule 13D's"). The Schedule 13D's note that, because each of these stockholders agreed to certain restrictions contained in a Registration Rights and Lockup Agreement dated as of December 1, 1997, such persons may be considered to be a "group" within the meaning of Section 13 of the Securities Exchange Act of 1934, as amended. However, the Schedule 13D's state that each of such persons disclaims beneficial ownership of the shares held by any other person. (3) Includes 37,500 shares that may be acquired under options that were exercisable within 60 days of March 28, 2001. Mr. Jensen's address is 2121 Precinct Line Road, Hurst, TX 76054. (4) As to each of Mr. Papa and Mr. Pisani, includes 106,250 shares that may be acquired under options that were exercisable within 60 days of March 28, 2000. The address of these stockholders is c/o NetLojix Communications, Inc., 501 Bath Street, Santa Barbara, CA 93101. (5) Includes 10,833 shares that may be acquired under options that were exercisable within 60 days of March 28, 2001. (6) Represents shares that may be acquired under options that were exercisable within 60 days of March 28, 2001. 45 (7) Includes 17,500 shares that may be acquired under options that were exercisable within 60 days of March 28, 2001. (8) Includes 2,000 shares owned by Mr. Wilson's spouse and 1,250 shares that may be acquired under options that were exercisable within 60 days of March 28, 2001. (9) Includes 379,583 shares that may be acquired under options that were exercisable within 60 days of March 28, 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS LONG DISTANCE SERVICES. Director Jeffrey J. Jensen, his father, Ronald L. Jensen, and his adult siblings own approximately 30% of UICI, a publicly-traded insurance and financial services company. NetLojix provides long distance telephone service and Internet access to certain affiliates of Mr. Jensen, his father and his adult siblings, including UICI. NetLojix billed UICI and such other affiliates approximately $4,059,000 in 2000 for such services. NetLojix believes that it provides the foregoing services on terms no less favorable to NetLojix than could be obtained from unrelated third parties. RENTERIA NOTE. In October 1996, Joseph Renteria, Jr., NetLojix's Vice President, Information Systems, financed the purchase of 53,608 shares of common stock through a loan from Ronald L. Jensen, who was then an affiliate of NetLojix. In 1998, NetLojix acquired the note representing this obligation, which was then in the amount of $80,400. At January 1, 2000, the total amount owing by Mr. Renteria under this note was $91,844, which was also the largest amount outstanding during 2000. At that time, the note was secured by 30,000 shares of NetLojix common stock owned by Mr. Renteria and bore an interest rate of 6% per annum. In February, 2000, Mr. Renteria paid the note down to a balance of $62,750 and the security for the note was reduced to 15,000 shares of stock. In December 2000, the parties reduced the amount of the note to $6,563. Mr. Renteria then paid this remaining amount through the cancellation of 15,000 of his shares of NetLojix common stock. CLARK DEBT. In December 1998 and February 1999, NetLojix advanced Craig R. Clark, its Vice President, Business Development, a total of $69,000. This debt is due on demand by NetLojix, and bears interest at a floating rate equal to the bank prime rate plus 2%. The balance owing by Mr. Clark on this debt, including accrued interest, is currently $31,000. The largest balance owing during 2000 on this debt was $56,000. Separately, in November and December 2000, NetLojix advanced Mr. Clark a total of $40,000. The note representing this obligation is due on demand by NetLojix, and bears interest at a rate of 6.15% per annum. The balance owing by Mr. Clark on this debt, including accrued interest, is currently $41,000. All of these loan obligations are unsecured. POLICY ON RELATED PARTY TRANSACTIONS. In connection with its listing on The Nasdaq SmallCap MarketSM, NetLojix has undertaken to conduct an appropriate review of all related party transactions on an ongoing basis and to utilize the Audit Committee to review potential conflict of interest situations where appropriate. 46 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The index to the financial statements and financial statement schedules filed as part of this report is set forth immediately following the signature page. (b) During the quarter ending December 31, 2000, NetLojix filed one Current Report on Form 8-K. On October 6, 2000, NetLojix filed a Form 8-K (Items 2 and 7) reporting the closing of the acquisition of CW Electronic Enterprises, Inc., a privately-held Illinois corporation, by NetLojix. No historical financial statements or pro forma financial information was required to be filed as a part of such Current Report. (c) The index to the exhibits filed as part of this report is set forth immediately following the financial statements. 47 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on it behalf by the undersigned, thereunto duly authorized. NETLOJIX COMMUNICATIONS, INC. Dated: April 2, 2001 By /s/ ANTHONY E. PAPA ------------------------------- Anthony E. Papa, Chairman of the Board and Chief Executive Officer Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 2nd day of April, 2001. By /s/ ANTHONY E. PAPA --------------------------- Anthony E. Papa, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) By /s/ JAMES P. PISANI --------------------------- James P. Pisani, President and Chief Operating Officer By /s/ GREGORY J. WILSON --------------------------- Gregory J. Wilson, Treasurer and Controller (Principal Financial Officer and Principal Accounting Officer) By /s/ JEFFREY J. JENSEN --------------------------- Jeffrey J. Jensen Director By /s/ ANTHONY D. MARTIN --------------------------- Anthony D. Martin Director INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Ernst & Young LLP, Independent Auditors............................... F-2 Report of KPMG LLP, Independent Auditors........................................ F-3 Consolidated Balance Sheets, December 31, 2000 and 1999......................... F-4 Consolidated Statements of Operations, Years ended December 31, 2000, 1999 and 1998................................................ F-5 Consolidated Statements of Stockholders' Equity, Years ended December 31, 2000, 1999 and 1998.......................................... F-6 Consolidated Statements of Cash Flows, Years ended December 31, 2000, 1999 and 1998................................................ F-7 Notes to Consolidated Financial Statements...................................... F-8 Schedule II - Valuation and Qualifying Accounts, Years ended December 31, 2000, 1999 and 1998.......................................... S-1
F-1 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders NetLojix Communications, Inc. We have audited the accompanying consolidated balance sheet of NetLojix Communications, Inc. as of December 31, 2000 and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at Item 14(a) for the year ended December 31, 2000. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. The consolidated financial statements and schedule of NetLojix Communications, Inc. for the years ended December 31, 1999 and 1998, were audited by other auditors whose report dated February 18, 2000, except for as to Note 13, which is as of March 2, 2000, expressed an unqualified opinion on those statements. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of NetLojix Communications, Inc. at December 31, 2000, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As more fully described in Note 1, the Company has incurred recurring operating losses and has a working capital deficiency. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. /s/ ERNST & YOUNG LLP Woodland Hills, California March 28, 2001 F-2 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders NetLojix Communications, Inc.: We have audited the accompanying consolidated balance sheet of NetLojix Communications, Inc. and subsidiaries as of December 31, 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the two-year period ended December 31, 1999. In connection with our audits of the consolidated financial statements, we also have audited the accompanying consolidated financial statement schedule as listed in the accompanying index for each of the years in the two-year period ended December 31, 1999. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of NetLojix Communications, Inc. and subsidiaries as of December 31, 1999, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related consolidated financial statement schedule for each of the years in the two-year period ended December 31, 1999, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG LLP Dallas, Texas February 18, 2000 F-3 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2000 AND 1999
2000 1999 ---- ---- ASSETS CURRENT ASSETS Cash and cash equivalents $ 184,000 $ 1,135,000 Accounts receivable, net 2,289,000 2,472,000 Due from affiliates 832,000 715,000 Prepaid expenses and other current assets 381,000 540,000 -------------------- --------------------- Total current assets 3,686,000 4,862,000 Property and equipment, net 1,502,000 918,000 Goodwill, net 4,585,000 3,802,000 Customer bases acquired and other intangibles, net 1,860,000 923,000 Other assets 86,000 9,000 -------------------- --------------------- Total assets $ 11,719,000 $ 10,514,000 ==================== ===================== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable and other accrued expenses $ 2,690,000 $ 1,876,000 Accrued network services costs 668,000 875,000 Litigation settlement liability 940,000 - Sales and excise tax payable 338,000 119,000 Unearned revenue 1,160,000 990,000 Revolving line of credit 1,178,000 - Other current liabilities 542,000 355,000 -------------------- --------------------- Total current liabilities 7,516,000 4,215,000 Long-term obligations 54,000 - -------------------- --------------------- Total liabilities 7,570,000 4,215,000 -------------------- --------------------- Commitments and contingencies (Notes 2, 9 and 12) - - STOCKHOLDERS' EQUITY Preferred stock, authorized 1,000,000 shares, $0.01 par value Series A convertible preferred stock, designated 250,000 shares, cumulative as to 8% dividends, 148,000 shares issued and outstanding (Liquidation preference of $728,000 at December 31, 2000 and 1999 including dividends in arrears) 1,000 1,000 Common stock, authorized 40,000,000 shares and 20,000,000 shares at December 31, 2000 and 1999, respectively, $0.01 par value, issued 14,482,000 and 12,563,000 shares at December 31, 2000 and 1999, respectively 145,000 126,000 Additional paid-in capital 28,452,000 23,651,000 Accumulated deficit (24,447,000) (17,477,000) Treasury stock, $0.01 par value, 163,000 and 151,000 common shares at December 31, 2000 and 1999 respectively. (2,000) (2,000) -------------------- --------------------- Total stockholders' equity 4,149,000 6,299,000 ==================== ===================== Total liabilities and stockholders' equity $ 11,719,000 $ 10,514,000 ==================== =====================
See accompanying notes. F-4 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998 ---- ---- ---- REVENUES $ 20,703,000 $ 16,864,000 $ 9,888,000 COST OF REVENUES 12,542,000 9,383,000 5,669,000 ---------------------- ---------------------- ----------------------- GROSS MARGIN 8,161,000 7,481,000 4,219,000 Operating expenses Selling, general and administrative 12,419,000 11,349,000 7,074,000 Litigation settlement costs 998,000 - - Provision for asset impairment 298,000 - Depreciation and amortization 1,232,000 1,022,000 612,000 ---------------------- ---------------------- ----------------------- Total operating expenses 14,947,000 12,371,000 7,686,000 ---------------------- ---------------------- ----------------------- OPERATING LOSS (6,786,000) (4,890,000) (3,467,000) Interest expense (104,000) (80,000) (31,000) Other income (expense), net (33,000) 23,000 92,000 ---------------------- ---------------------- ----------------------- Loss from continuing operations before income taxes (6,923,000) (4,947,000) (3,406,000) Income tax benefit - - 135,000 ---------------------- ---------------------- ----------------------- Loss from continuing operations (6,923,000) (4,947,000) (3,271,000) Discontinued operations Loss from operations of discontinued residential long distance business (net of income tax benefit of $0, $0, and $1,391,389 in 2000, 1999 and 1998, respectively) - (3,031,000) (2,531,000) Gain on disposition - 5,780,000 - ---------------------- ---------------------- ----------------------- Income (loss) from discontinued operations - 2,749,000 (2,531,000) ---------------------- ---------------------- ----------------------- NET LOSS $ (6,923,000) $ (2,198,000) $ (5,802,000) ====================== ====================== ======================= Loss from continuing operations per common share - basic and diluted $ (.51) $ (.49) $ (.35) Income (loss) from discontinued operations per common share - basic and diluted - .26 (.26) ---------------------- ---------------------- ----------------------- Net loss per common share - basic and diluted $ (.51) $ (.23) $ (.61) ====================== ====================== ======================= Weighted average number of common shares - basic and diluted 13,699,734 10,794,584 9,633,474 ====================== ====================== =======================
See accompanying notes. F-5 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2000, 1999 and 1998
PREFERRED STOCK COMMON STOCK SHARES AMOUNT SHARES ------ ------ ------ BALANCES, December 31, 1997 208,000 $ 2,000 11,051,000 Conversion of Series A preferred stock (60,000) (1,000) 60,000 Issuance of common stock for exercise of options and restricted common stock - - 473,000 Issuance of common stock for acquisitions - - 680,000 Expired put options - - 48,000 Called put options 186,000 Purchase of officer note receivables - - - Stock compensation earned - - - Retirement of treasury stock - - (2,201,000) Net loss - - - --------------- ---------------------- ---------------------- BALANCES, December 31, 1998 148,000 1,000 10,297,000 Issuance of common stock for exercise of options and restricted common stock - - 315,000 Stock compensation earned - - - Issuance of common stock per equity line of credit - - 1,067,000 Purchase of treasury stock - - - Shares acquired in legal settlement - - - Cancelled put options - - 113,000 Retire treasury stock - - (36,000) Issuance of Series B preferred stock 1,500 - 3,000 Preferred stock dividends paid - - - Conversion of preferred stock (1,500) - 804,000 Net loss - - - --------------- ---------------------- ---------------------- BALANCES, December 31, 1999 148,000 1,000 12,563,000 Issuance of common stock for exercise of options - - 774,000 Sale of common stock - - 375,000 Stock compensation earned - - - Issuance of warrants for professional services - - - Purchase of treasury stock - - - Cancellation of common stock - - (20,000) Cancellation of note issued for common stock - - (15,000) Common stock issued in connection with acquisitions - - 805,000 Preferred stock dividends paid - - - Net loss - - - --------------- ---------------------- ---------------------- 148,000 $ 1,000 14,482,000 =============== ====================== ======================
ADDITIONAL PAID-IN (ACCUMULATED AMOUNT CAPITAL DEFICIT) ------ ------- -------- BALANCES, December 31, 1997 $ 111,000 $ 17,138,000 $ (9,423,000) Conversion of preferred stock 1,000 - - Issuance of common stock for exercise of options and restricted common stock 4,000 513,000 - Issuance of common stock for acquisitions 7,000 1,527,000 - Expired put options - 37,000 - Called put options 2,000 373,000 - Purchase of officer note receivables - (435,000) - Stock compensation earned - 477,000 - Retirement of treasury stock (22,000) - - Net loss - - (5,802,000) ------------------ ----------------- ---------------------- BALANCES, December 31, 1998 103,000 19,630,000 (15,225,000) Issuance of common stock for exercise of options and restricted common stock 3,000 482,000 - Stock compensation earned - 561,000 - Issuance of common stock per equity line of credit 11,000 1,917,000 - Purchase of treasury stock - (77,000) - Shares acquired in legal settlement - (430,000) - Cancelled put options 1,000 168,000 - Retire treasury stock - - - Issuance of preferred stock - 1,408,000 - Preferred stock dividends paid - - (54,000) Conversion of preferred stock 8,000 (8,000) - Net loss - - (2,198,000) ------------------ ----------------- ---------------------- BALANCES, December 31, 1999 126,000 23,651,000 (17,477,000) Issuance of common stock for exercise of options 7,000 1,223,000 - Sale of common stock 4,000 1,436,000 - Stock compensation earned - 27,000 - Issuance of warrants for professional services - 216,000 - Purchase of treasury stock - (38,000) - Cancellation of common stock - - Cancellation of note issued for common stock - 30,000 Common stock issued in connection with acquisitions 8,000 1,907,000 - Preferred stock dividends paid - - (47,000) Net loss - - (6,923,000) ------------------ ----------------- ---------------------- $ 145,000 $ 28,452,000 $ (24,447,000) ================== ================= ======================
TREASURY STOCK SHARES AMOUNT TOTAL ------ ------ ----- BALANCES, December 31, 1997 (2,000,000) $ (20,000) $ 7,808,000 Conversion of preferred stock - - - Issuance of common stock for exercise of options and restricted common stock - - 517,000 Issuance of common stock for acquisitions - - 1,534,000 Expired put options - - 37,000 Called put options (202,000) (2,000) 373,000 Purchase of officer note receivables - - (435,000) Stock compensation earned - - 477,000 Retirement of treasury stock 2,202,000 22,000 - Net loss - - (5,802,000) ---------------- ------------------ ------------------ BALANCES, December 31, 1998 - - 4,509,000 Issuance of common stock for exercise of options and restricted common stock - - 485,000 Stock compensation earned - - 561,000 Issuance of common stock per equity line of credit - - 1,928,000 Purchase of treasury stock (11,000) - (77,000) Shares acquired in legal settlement (176,000) (2,000) (432,000) Cancelled put options - - 169,000 Retire treasury stock 36,000 - - Issuance of preferred stock - - 1,408,000 Preferred stock dividends paid - - (54,000) Conversion of preferred stock - - - Net loss - - (2,198,000) ---------------- ------------------ ------------------ BALANCES, December 31, 1999 (151,000) (2,000) 6,299,000 Issuance of common stock for exercise of options - - 1,207,000 Sale of common stock - - 1,463,000 Stock compensation earned - - 27,000 Issuance of warrants for professional services - - 216,000 Purchase of treasury stock (12,000) - (38,000) Cancellation of common stock - Cancellation of note issued for common stock 30,000 Common stock issued in connection with acquisitions - - 1,915,000 Preferred stock dividends paid - - (47,000) Net loss - - (6,923,000) ---------------- ------------------ ------------------ (163,000) $ (2,000) $ 4,149,000 ================ ================== ==================
See accompanying notes. F-6 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss from continuing operations $ (6,923,000) $ (4,947,000) $ (3,271,000) Adjustments to reconcile net loss from continuing operations to cash used by continuing operating activities: Depreciation and amortization 1,232,000 1,022,000 612,000 (Gain)loss on disposition of assets - 10,000 (87,000) Provision for asset impairments 298,000 - - Provision for doubtful accounts 551,000 296,000 384,000 Deferred income taxes - - (499,000) Cancellation of note issued for common stock 30,000 - - Issuance of warrants for professional services 216,000 - - Litigation settlement balance 940,000 - - Stock compensation earned 27,000 156,000 373,000 Changes in operating assets and liabilities: Accounts receivable (163,000) (1,473,000) (717,000) Due from affiliates (116,000) 58,000 74,000 Federal and state income tax receivable - 1,325,000 (741,000) Other current assets 126,000 (642,000) 342,000 Accounts payable and accrued liabilities 376,000 (499,000) (550,000) Due to affiliate - - (24,000) ------------ ------------- ------------- Cash used by continuing operating activities (3,406,000) (4,694,000) (4,104,000) Cash used by discontinued operating activities - (2,983,000) (1,875,000) ------------ ------------- ------------- Cash used by operating activities (3,406,000) (7,677,000) (5,979,000) CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (849,000) (370,000) (323,000) Additions to property and equipment - discontinued operations - (410,000) (150,000) Payments received on loans to affiliates - discontinued operations - - 1,799,000 Cash paid in acquisitions (403,000) - (474,000) Proceeds from sale of property and equipment - 1,000 94,000 Proceeds from sale of property and equipment - discontinued operations - 7,000 - ------------ ------------- ------------- Cash provided (used) by investing activities (1,252,000) (772,000) 946,000 CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on capital leases (45,000) (46,000) (59,000) Principal payments on capital leases - discontinued operations - (21,000) - Issuance of common stock for exercise of options 1,230,000 485,000 518,000 Issuance of common stock on equity line of credit - 1,928,000 - Issuance of Series B preferred stock - 1,408,000 - Sale of common stock 1,440,000 - - Preferred stock dividend payments (47,000) (55,000) - Borrowings on line of credit 15,709,000 2,617,000 - Amounts paid on line of credit (14,542,000) (2,617,000) - Borrowings on short-term note - discontinued operations - 2,000,000 - Borrowings on long-term note - discontinued operations - 3,160,000 - Borrowings on line of credit - discountinued operations - 24,607,000 9,754,000 Amounts paid on line of credit - discontinued operations - (24,716,000) (8,641,000) Purchase from third party of note receivable for stock purchase - - (435,000) Purchase of treasury stock (38,000) (77,000) - ------------ ------------- ------------- Cash provided by financing activities 3,707,000 8,673,000 1,137,000 ------------ ------------- ------------- Net increase (decrease) in cash and cash equivalents (951,000) 224,000 (3,896,000) Cash and cash equivalents at beginning of period 1,135,000 911,000 4,807,000 ------------ ------------- ------------- Cash and cash equivalents at end of period $ 184,000 $ 1,135,000 $ 911,000 ============ ============= ============= Cash paid (received) during the period: Interest - continuing operations $ 103,781 $ 84,000 $ 31,000 Interest - discontinued operations - 309,000 55,000 Income taxes - continuing operations - (112,000) (51,000) Income taxes - discontinued operations - (1,163,000) (436,000) Noncash investing and financing activities: Common stock issued for acquisitions $ 1,915,000 $ - $ 1,534,000 Common shares acquired in legal settlement - (432,000) - Net liabilities relinquished in Matrix sale - 5,780,000 -
See accompanying notes. F-7 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) Business and Background NetLojix Communications, Inc. (the "Company") is a provider of network and hosting infrastructure, web application development and technical support to the business market, with offices principally located in California, Illinois, New York and Texas. The Company provides enterprise-wide solutions integrating broadband connectivity, hosting, co-location, web application development, system integration, maintenance and voice connectivity. The Company network infrastructure and Internet hosting platform employ proprietary as well as existing technologies that enable its customers to outsource their eBusiness initiatives including hosting, co-location, transaction management, bandwidth, data storage and security. The Company is organized into three primary business segments: Network Connectivity, Technical Support Services and Application Development and Hosting. Services provided by the Company include the transport of data, voice and Internet traffic; systems integration, service and technical support; and application development and web hosting. Through a value-added sales process, the Company designs, installs and manages its customers' networks. The Company will provide a host of additional value added services assisting its customers to create and manage enhanced intranet and extranet applications. The Company cross-markets to its customer base a variety of traditional telecommunications products and services such as long distance telephone service, executive calling cards and video/audio conferencing. On November 30, 1999, the Company sold its wholly-owned subsidiary, Matrix Telecom, Inc. Matrix Telecom represented all of the Company's residential long distance business. As a result of the Company's decision to exit the residential long distance business, the Company's consolidated financial statements as of December 31, 1999 and 1998, and for the years ended December 31, 1999 and 1998 reflect the Company's residential long distance business as a discontinued operation. (B) Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. (C) Basis of Presentation The accompanying financial statements have been prepared assuming the Company will continue as a going concern. The Company has experienced recurring losses and has a deficiency in working capital at December 31, 2000. The Company is planning for its operations during 2001 to generate sufficient working capital for it to continue as a going concern without the need for additional financing. During late 2000, the Company took steps to improve its cash flows from operations, which included a reduction in the number of employees, closures of offices and a refocusing of the Company's marketing and sales activities on more profitable lines of business. Although there can be no assurance that these steps will result in the projected level of cash flow from operations, management believes that the Company's operations will generate sufficient working capital to maintain its ongoing activities through at least December 31, 2001. (D) Cash and Cash Equivalents The Company considers all demand deposits, time deposits, and other highly liquid investments with an original maturity at date of purchase of less than ninety days to be cash equivalents. F-8 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 (E) Accounts Receivable Accounts receivable are net of allowances for doubtful accounts and other provisions of $565,000 and $290,000 as of December 31, 2000 and 1999, respectively. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of its customers, historical trends and other information. (F) Revenue Recognition Revenues for long distance, frame relay, Internet, and applications development and web hosting services are recognized as service is provided. Amounts paid in advance are recorded as unearned revenue and recognized as services are provided. Within the Technical Support Services segment, the Company sells its services under hourly service contracts (whether prepaid or billed in arrears), flat fee service call contracts or prepaid maintenance contracts. For prepaid maintenance contracts, the Company recognizes revenues ratably over the service period. For all other services, revenues are recognized when the services are rendered. (G) Property and Equipment Property and equipment are recorded at cost. Maintenance and repairs are charged against income as incurred, while renewals and major replacements are capitalized. The cost and related accumulated depreciation of assets sold or retired are removed from the accounts, and any resulting gain or loss is reflected in operations. The Company provides depreciation of fixed assets using the straight-line method over the following estimated useful lives of the respective assets. Computer equipment 2-5 years Office furniture and equipment 1-7 years Leasehold improvements Lease term Vehicles 3 years
(H) Goodwill Goodwill represents the excess of purchase price over the fair value of net assets acquired in various acquisitions and is being amortized over fifteen years. The Company assesses the recoverability of its recorded goodwill by determining whether the amortization of the goodwill balance over its remaining life could be recovered through undiscounted future cash flows of the acquired businesses. At December 31, 2000, the Company calculated that its recorded goodwill on certain acquisitions in the amount of $298,000 would not be recovered on such a basis and was written off. Goodwill is recorded net of accumulated amortization of $618,000 and $336,000 as of December 31, 2000 and 1999 respectively. (I) Customer Bases Acquired and Other Intangible Assets Customer bases acquired of $1,685,000 and $923,000 as of December 31, 2000 and 1999, respectively, is recorded net of accumulated amortization of $1,032,000 and $660,000, respectively. The customer bases acquired are recorded in other assets and are being amortized on a straight-line basis over five years. The Company also has included in intangible assets the covenants-not-to-compete obtained in connection with two acquisitions in 2000, the balance of which at December 31, 2000 is $175,000, net of accumulated amortization of $35,000. These covenants-not-to-compete are being amortized on a straight line basis over two years. The Company assesses the recoverability of these intangible assets by comparing the recorded value to estimated undiscounted future cash flows from the use of the asset. The amount of impairment, if any, is measured based on the difference between the recorded net book value and the estimated fair value of the intangible assets. The assessment of the recoverability of the intangible assets will be impacted if the estimated fair value declines below their recorded book values. F-9 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 (J) Use of Estimates Management of the Company has made a number of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. (K) Concentrations of Credit Risk The Company's customers are primarily small to mid-size business owners and are not concentrated in any specific geographic region of the United States. The Company generally extends credit to its customers and accounts receivable are generally not collateralized. As of December 31, 2000, five customers comprise $1,626,000, or 71%, of the accounts receivable balance as listed below. S G Cowen $ 676,000 Specialized Card 352,000 Infosys Technologies Limited 336,000 UICI 148,000 Excell Agent Services 114,000 -------------- $ 1,626,000 ==============
In addition, S G Cowen represents approximately 12% of the Company's revenues for the year ended December 31, 2000. (L) Financial Instruments The Company's financial instruments include cash, receivables, payables, and accrued expenses. The carrying amount of such financial instruments approximates fair value because of the short maturity of these instruments. (M) Loss Per Share Basic and diluted loss per share has been computed using the weighted average number of shares of common stock outstanding during the period. The Company has excluded all outstanding convertible preferred stock and outstanding options and warrants to purchase common stock from the calculation of diluted net loss per share, as such securities are antidilutive for all periods presented. Comprehensive loss for the years ended December 31, 2000, 1999 and 1998 and is equal to net loss reported for such periods. (N) Reclassifications Certain reclassifications have been made to prior period amounts in order to conform to current year presentation. (O) Recently-issued accounting pronouncements In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance for revenue recognition under various circumstances. The accounting and disclosures prescribed by SAB 101 became effective for the fourth quarter of the Company's fiscal year ended December 31, 2000. Complying with SAB 101 did not require any change in the Company's revenue recognition policies and did not effect the Company's consolidated financial position or F-10 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 results of operations. (2) ACQUISITIONS AND DISPOSITIONS MATRIX TELECOM, INC. On December 1, 1997, the Company and Matrix Telecom completed a share for share exchange of common stock (the "Share Exchange"). For accounting purposes, the Share Exchange was treated as a reverse acquisition of the Company by Matrix Telecom. The Company was the legal acquirer and, accordingly, the Share Exchange was affected by the issuance of the Company's common stock in exchange for all of the common stock then outstanding of Matrix Telecom. In addition, holders of outstanding Matrix Telecom stock options received non-qualified stock options of the Company. Immediately after the Share Exchange the former shareholders of Matrix Telecom held approximately 84% of the then outstanding common stock of the Company. On November 30, 1999, the Company sold all of the stock of Matrix Telecom to Matrix Acquisition Holdings Corp., a wholly-owned subsidiary of Platinum Equity Holdings, LLC. (Platinum) and recorded a gain of $5,780,000. The purchase price for the Matrix Telecom stock was valued at $6,052,000 and consisted of four components. First, the Company received a credit against future charges incurred for long distance wholesale telephone traffic pursuant to a telecommunications service contract with Matrix Telecom. The amount of the credit was calculated to be approximately $614,000. Second, $4,190,000 in intercompany indebtedness owed to Matrix Telecom by the Company was eliminated or forgiven. Third, the federal income tax refunds paid to or due Matrix Telecom in the total amount of $1,248,000 were assigned to the Company. Fourth, the Company was to receive a possible future cash payment based upon Matrix Telecom's Internet service customer base. The Company currently does not believe that it will receive any amounts based on Matrix Telecom's Internet services. The Company also received an indemnity from Platinum against certain claims or liabilities arising under the Company's secured credit facility with Coast Business Credit. The Company also was released by Coast Business Credit from any claims or liabilities relating to borrowings secured by the assets of Matrix Telecom. The residential long distance operations of Matrix Telecom have been reflected as a discontinued operation and all prior period amounts have been restated. The final amount of the purchase price is subject to adjustment based on finalization of a balance sheet for Matrix Telecom as of August 31, 1999 and agreement by both parties. The Company has been notified by Platinum that it materially disagrees with the balance sheet of Matrix Telecom prepared by the Company. To date, the Company has attempted to resolve the matter, but the buyer has resisted submitting the matter to an independent firm of accountants chosen by the parties for final resolution, as required by the contract. Any adjustment in the purchase price would affect the purchase price and the recorded gain. At this time, the Company does not believe that the ultimate resolution of the items in dispute will materially affect the recorded gain. F-11 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 DIGITAL MEDIA, INC. ("DMI") Effective September 1998, the Company acquired all of the capital stock of DMI, a California based developer of multimedia software. The Company exchanged 30,000 shares of its common stock valued at $71,000 for all of the outstanding common stock of DMI. The acquisition was accounted for under the purchase method of accounting. The assets and liabilities of DMI were recorded at their historical cost, which approximated their fair value at the date of acquisition. The Company recorded goodwill of approximately $117,000, which represented the excess of the purchase price over the fair value of the net identifiable assets acquired. The goodwill was being amortized on a straight-line basis over fifteen years. As of December 31, 2000, the Company determined that the goodwill was impaired and the remaining balance of $111,000 was written off as of that date. REMOTE LOJIX/PCSI, INC. ("RLI") Effective November 1998, the Company acquired all of the capital stock of RLI, a New York based provider of information technology services to corporate customers. The Company exchanged 650,000 shares of its common stock valued at $1,463,000 for all of the outstanding common stock of RLI. The Company assumed the outstanding balance of a $500,000 loan to RLI. The acquisition was accounted for under the purchase method of accounting. The assets and liabilities of RLI were recorded at their historical cost, which approximated their fair value at the date of acquisition. The Company recorded goodwill of approximately $4,365,000, which represented the excess of the purchase price over the fair value of the net identifiable assets acquired. The goodwill is being amortized on a straight-line basis over fifteen years During 1999, the Company settled all outstanding claims against the former majority stockholder of RLI in exchange for relinquishment of 176,262 shares of common stock of the Company. The relinquishment was recorded as a reduction of goodwill in the amount of $432,000 during 1999. SMITH TECHNOLOGY SOLUTIONS, INC. ("STS") Effective August 2000, the Company acquired all the outstanding shares of STS. STS provides local and wide area network design, integration and support, and web-site design and management for businesses in California. The Company paid cash of $60,000 and issued 250,000 shares of its common stock valued at approximately $484,417 in exchange for all the outstanding shares of STS. The Company also paid $90,000 for a consulting agreement with an officer of STS. In addition, the Company incurred acquisition related expenses of approximately $107,000. The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the tangible and intangible net assets acquired on the basis of their respective fair values on the acquisition date. The total purchase price was allocated to net tangible assets and liabilities of approximately $152,000 and intangible assets, including STS' customer base of $356,000, a covenant not to compete of $100,000 and goodwill of $262,000. Goodwill is being amortized over its estimated useful life of fifteen years. The other acquired intangible assets are being amortized over their estimated useful lives of five and two years, respectively. F-12 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 CW ELECTRONIC ENTERPRISES, INC. ("CWE(2)") Effective September 2000, the Company acquired all the outstanding shares of CW Electronic Enterprises, Inc. (dba CWE(2) Network Systems) ("CWE(2)"). CWE(2) provides local and wide area network design, integration and support, and web site design and hosting management for mid-sized businesses in the Midwest. The Company paid cash of $150,000 and issued 500,000 shares of its common stock valued at approximately $1,214,000 in exchange for all the outstanding shares of CWE(2). In addition the Company incurred acquisition related expenses of approximately $126,000. The acquisition was accounted for using the purchase method of accounting and accordingly, the purchase price was allocated to the tangible and intangible net assets acquired on the basis of their respective fair values on the acquisition date. The Company assumed net tangible liabilities of $293,000 and recorded intangible assets, including CWE(2)'s customer base of $756,000, a covenant-not-to-compete of $100,000 and goodwill of $921,000. Goodwill is being amortized over its estimated useful life of fifteen years. The other acquired intangible assets are being amortized over their estimated useful lives of two to five years. OTHER During 2000, in separate transactions, the Company acquired the assets of two other corporations in the IT support business. In these transactions, the Company issued 55,000 shares of the Company's common stock and accounted for them using the purchase method. The Company recorded goodwill of approximately $219,000, which represented the excess of the purchase price over the fair value of the net identifiable assets acquired. The goodwill was being amortized on a straight line basis over fifteen years. At December 31, 2000, the Company determined that the goodwill was impaired and the remaining balance of $187,000 was written off as of that date. These acquisitions were not included in the pro forma table below because the results of operations presented would not have differed materially. Unaudited pro forma results of operations of the Company as if the acquisitions of STS and CWE(2) had occurred as of the beginning of the years ended December 31, 2000 and 1999:
Years ended December 31, ----------------------------- 2000 1999 ---- ---- Revenues $ 23,296,000 $ 20,395,000 Operating loss (7,071,000) (4,863,000) Loss from continuing operations (6,934,000) (4,921,000) Pro forma loss from continuing operations per common share $ (.50) $ (.43)
The pro forma financial information has been prepared for comparative purposes only and does not purport to indicate the results of operations that would have occurred had the acquisition been made at the beginning of the periods indicated, or which may occur in the future. The allocations related to the acquisitions made during 2000 are preliminary and subject to adjustments as the Company completes its review and evaluation of the acquired assets and assumed liabilities. F-13 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 (3) DISCONTINUED OPERATIONS Selected financial information for the discontinued residential long distance operations is as follows:
YEARS ENDED DECEMBER 31, --------------------------------------- 1999 1998 ----------- ----------- Revenues $ 18,993,000 $ 34,126,000 Costs and expenses (22,024,000) (38,048,000) ----------- ----------- Loss before income tax benefit (3,031,000) (3,922,000) Income tax benefit -- 1,391,000 ----------- ----------- Loss from operations of discontinued operations $ (3,031,000) $ (2,531,000) =========== ===========
(4) PROPERTY AND EQUIPMENT Property and equipment consisted of the following:
DECEMBER 31, --------------------------------- 2000 1999 --------- --------- Computer equipment $ 2,109,000 $ 1,152,000 Office furniture and equipment 454,000 423,000 Leasehold improvements 184,000 135,000 Vehicles 34,000 -- --------- --------- Total property and equipment 2,781,000 1,710,000 Accumulated depreciation and amortization (1,279,000) (792,000) --------- --------- Property and equipment, net $ 1,502,000 $ 918,000 ========= =========
The Company recognized total depreciation expense of $488,000, $714,000 and $737,000 for 2000, 1999 and 1998, respectively. Depreciation expense related to continuing operations was $488,000, $372,000 and $254,000 for the same periods. (5) STOCKHOLDERS' EQUITY COMMON STOCK SUBJECT TO PUT OPTION In 1996, approximately 482,000 shares of common stock were sold to officers of the Company at $1.50 per share. Upon the termination of the recipient's employment, such shares could be put or called at a price of $1.50 per share plus the earnings per share or minus the losses per share of the Company from the period July 1, 1996 to the end of the month prior to the date of notification of termination of employment by the employee or the Company. As of December 31, 1999 all put/call rights had been rescinded.
SHARES AMOUNT ------- ------- Balance, January 1, 1998 $ 386,000 $ 579,000 Vested shares no longer subject to put (48,000) (72,000) Called shares subject to put (225,000) (338,000) ------- ------- Balance, December 31, 1998 113,000 169,000 Vested shares no longer subject to put (38,000) (56,000) Cancellation of put/call rights (75,000) (113,000) Balance, December 31, 1999 $ -- $ -- ======= =======
F-14 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 ISSUANCE AND CONVERSION OF PREFERRED STOCK The Series A Convertible Preferred Stock ("Series A Stock") is convertible, on a one-to-one basis, into shares of the Company's common stock. During 1998, a total of 60,000 shares of the Series A Stock was converted to 60,000 shares of the Company's common stock. On April 13, 1999, the Company sold 1,500 shares of its newly-designated Series B Convertible Preferred Stock (the "Series B Stock") to three private investors for $1,500,000. The Series B Convertible Preferred Stock was convertible into common stock at the option of the Series B investors at any time. The conversion price was the lesser of $6.875 or 89% of the closing bid price for the Company's common stock at the time of conversion. All of the shares of the Series B Stock were converted into an aggregate of 804,000 shares of the Company's common stock during 1999. The Company also issued the Series B investors warrants to purchase up to 20,000 shares of Common Stock at a price of $8.60 per share. The warrants may be exercised beginning September 30, 1999, and expire on March 31, 2002. During 1999, 9,000 of such warrants were cancelled. The Company paid Trinity Capital Advisors, Inc. $60,000 as compensation for financial advisory services in connection with the placement of the Series B Stock. EQUITY LINE AGREEMENT On April 23, 1999, the Company entered into an equity line of credit agreement with Cambois Finance, Inc. ("Cambois"), through which the Company may sell or "put" the Company's common stock to Cambois subject to the satisfaction of several conditions. The equity line agreement provides for Cambois to purchase up to $13,500,000 of the Company common stock, subject to the Company filing and maintaining an effective registration statement, trading price and volume minimums, and limits on the amount and frequency on sales of common stock under the line. The Company filed the registration statement, which was declared effective by the Securities and Exchange Commission (the "SEC") on August 25, 1999. As of December 31, 2000, the Company had put a total of 1,067,000 shares of its common stock to Cambois for $2,000,000 pursuant to the equity line agreement. The equity line agreement provides that, without a vote of the Company's common stockholders, the Company may not issue more than 2,103,939 shares of common stock in the aggregate to Cambois under the equity line, which number of shares is equal to 19.96% of the outstanding shares of the Company's common stock on the date of the equity line agreement. As a result, as of December 31, 2000, the Company could sell up to an additional 1,037,000 shares to Cambois. To issue shares in excess of that amount under the equity line agreement, the Company would have to register additional shares with the SEC, as well as obtain stockholder approval. Netlojix cannot put stock to Cambois without Cambois's approval if the bid price for its common stock is less than $2.26 per share. NetLojix's possible delisting from The Nasdaq SmallCap Market would prevent NetLojix from utilizing the equity line agreement without Cambois's approval even if the bid price for NetLojix's stock is above $2.26 per share. The Company issued 3,000 shares of its common stock to Trinity Capital Advisors, Inc. as compensation for financial advisory services in connection with the Cambois agreement. COMMON STOCK TRANSACTIONS In December 1998, the Company retired all of its then outstanding treasury stock, which consisted of 2,201,601 shares. During February 1999 and January 2000 the Company purchased 11,000 and 12,000 shares of its F-15 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 common stock at average prices of $6.64 and $3.17, respectively, in the open market pursuant to the Company's 1999 and 2000 GO Plans. The GO Plans were established to provide the Company's employees with cash bonuses for up to four years to promote longevity of employment. For four consecutive years starting in February 2000 and January 2001, respectively, the Company is to sell 25% of the shares held under the each GO Plan and distribute the proceeds as cash bonuses to the employees who were employed at both the date of the establishment of the respective GO Plans and at the date of distribution. During 1999, the former majority stockholder of RLI relinquished 176,000 shares of the Company's common stock to the Company in accordance with two separate legal settlements related to disputes concerning the purchase of RLI. These shares were originally issued in connection with the purchase of RLI. Of these shares, 140,000 shares are held as treasury stock while 36,000 shares were subsequently canceled and retired. The value of the shares relinquished was recorded as an adjustment to goodwill. On March 3, 2000, the Company raised net proceeds of $1,440,000 through a private placement of 375,000 shares of common stock at $4.00 per share. The purchaser was AMRO International, S.A., an entity organized under the laws of Panama. In connection with the placement, the Company also granted AMRO warrants to purchase up to 75,000 shares of the Company's common stock at a price of $5.25 per share. These warrants expire March 1, 2003. A registration statement to register the public resale of these shares by AMRO was declared effective by the SEC on June 7, 2000. On May 25, 2000, the Company held its annual meeting of stockholders. At that meeting the stockholders approved an amendment to the certificate of incorporation increasing the number of authorized shares of common stock from 20,000,000 shares to 40,000,000 shares. ISSUANCE OF COMMON STOCK WARRANTS In January 2000, the Company retained Kaufman Bros., L.P ("Kaufman Bros.") to act as the Company's financial advisor and investment banker. As compensation for investment banking services, the Company agreed to pay $25,000 and issue 100,000 warrants expiring in January 2005 to purchase common stock of the Company at an exercise price of $3.28. Using the Black-Scholes pricing model, the fair value of the warrants was estimated to be $216,000, which was recorded as an expense during the first quarter of 2000. In addition, the Company has agreed to compensate Kaufman Bros. for any financing or merger transactions facilitated by them in accordance with a specified fee schedule. The initial term of this agreement with Kaufman Bros. expired on August 31, 2000, and the agreement is automatically renewing on a monthly basis until terminated in writing by either the Company or Kaufman Bros. The agreement was effective at December 31, 2000. PREFERRED STOCK DIVIDENDS As a result of issuance of the Series B preferred stock, the Company was required to account for the benefit of the conversion feature in a manner similar to a preferred stock dividend equal to the difference between the market price of the Company's common stock at the date the Company committed to issue the Series B stock and the conversion price, times the number of common shares issuable upon conversion. The effect of these preferred stock dividends on loss per share was recognized ratably over the period to the earliest conversion date (90 days from date of issuance). During 1999, the Company included preferred dividends related to the conversion feature on Series B stock of $256,593 in the calculation of loss per share. F-16 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 On each of January 31, 1999, July 31, 1999, January 31, 2000 and July 31, 2000, the Company declared and paid in cash semi-annual dividends of $24,000 each to the holders of the Company's Series A convertible preferred stock. On September 30, 1999, the Company declared and paid in cash quarterly dividends of $7,000 to the holders of the Company's Series B preferred stock. STOCK OPTION GRANTS NETLOJIX OPTIONS--Prior to the Share Exchange, the Company adopted the 1997 Incentive Stock Option Plan (the "NetLojix 1997 Plan") for stock option grants to officers and key employees. The NetLojix 1997 Plan authorizes grants of options to purchase up to 250,000 shares of authorized but unissued common stock and 125,000 shares of restricted common stock of the Company. Stock options are to be granted with an exercise price greater than or equal to the stock's fair market value at the date of grant. Options generally vest 25% after one year and 25% each year thereafter until fully vested. Such options typically expire after ten years. As of December 31, 2000, 58,000 options had been exercised and 116,000 options were outstanding. On January 1, 1998, the Company granted options to purchase 75,000 shares of the Company's common stock at an exercise price of $1.50 per share to one of its distributors. On March 1, 1998, the Company granted options to purchase 100,000 shares of the Company's common stock at an exercise price of $1.50 per share to another one of its distributors. These options were to become exercisable based on qualified billings to long distance customers generated by the optionees from the respective dates of grant through December 31, 2000. As of December 31, 1999, and in connection with the sale of Matrix Telecom, all grants under these agreements had been cancelled except for 27,000 currently-exercisable options left outstanding with an expiration date of December 31, 2002. On February 24, 1998, the Company's Board of Directors approved a grant of a total of 120,000 shares of restricted common stock to two board members pursuant to the NetLojix 1997 Plan. During 1998 and 2000, 60,000 shares and 60,000 shares respectively were vested. As of December 31, 2000, all 120,000 shares of restricted common stock are vested. During 1998, the Company adopted the 1998 Stock Incentive Plan (the "NetLojix 1998 Plan"), which initially provided for the issuance of up to 1,500,000 shares of NetLojix common stock pursuant to stock options and issuances of restricted stock, as well as for the grant of stock appreciation rights. At the Company's annual meeting on May 25, 2000, the stockholders approved an amendment to the 1998 Stock Incentive Plan increasing the number of shares authorized for issuance under the plan by 1,500,000 shares. Stock options are generally to be granted with an exercise price greater than or equal to the stock's fair market value at the date of grant. Options generally vest 25% after one year and 25% each year thereafter until fully vested. Such options typically expire after ten years. As of December 31, 2000, the Company had granted options to purchase 3,233,000 shares of the Company's common stock and granted 20,000 shares of restricted stock under the NetLojix 1998 Plan. During 2000, all 20,000 shares were cancelled. Exercise prices range from $1.875 to $5.625 per share. Options to purchase 1,786,000 shares were outstanding as of December 31, 2000. During 1999, the Company granted nonstatutory stock options to three of its board members to purchase a total of 75,000 shares of the Company's common stock at exercise prices ranging from $4.625 to $4.88 (average exercise price of $4.82 per share), which was equivalent to the fair market value of the stock F-17 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 at the respective dates of grant. The stock options vest at a rate of 50% per year over two years and were granted pursuant to the NetLojix 1998 Plan. During 1999, the Company granted incentive stock options to four officers to purchase a total of 350,000 shares of the Company's common stock at exercise prices ranging from $4.88 to $5.625 (average exercise price of $4.99 per share) which was equivalent to the fair market value of the stock at the respective dates of grant. The options vest at a rate of 25% per year over four years and were granted pursuant to the NetLojix 1998 Plan. The Company also granted in 1999 incentive stock options to various non-executive managers and employees to purchase a total of 100,000 shares of the Company's common stock at exercise prices ranging from $1.875 to $4.15 (average exercise price of $3.51 per share) which was equivalent to the fair market value of the stock at date of grant. The options vest at a rate of 25% per year over four years and were granted pursuant to the NetLojix 1998 Plan. In 2000, the Company granted 1,610,250 options to employees and directors. Of these, 310,500 were granted at exercise prices of $.25 to $.38, 195,000 were granted at exercise prices of $1.06 to $2.25, 999,750 were granted at exercise prices of $2.31 to $3.31 and 105,000 were granted at exercise prices of $3.91 to $5.38. All options granted in 2000 were pursuant to the NetLojix 1998 Stock Incentive Plan. MATRIX TELECOM OPTIONS--Prior to the Share Exchange, the Board of Directors of Matrix Telecom approved the grant of stock options for certain of its officers and employees. Stock option transactions of Matrix Telecom are included in the table below. At the time of the Share Exchange, Matrix Telecom had 22,000 options outstanding to purchase its common stock. In connection with the Share Exchange, the Company reissued these stock options and they vested immediately. These reissued options expire in December 2002. The Company applies APB Opinion No. 25 in accounting for the NetLojix 1997 Plan, NetLojix 1998 Plan and the Matrix Telecom options discussed above; accordingly, no compensation cost has been recognized in the financial statements for stock options issued to employees. For stock options granted to non-employees, the Company accounts for such options in accordance with the requirements of SFAS No. 123. Had the Company determined compensation cost based on the fair value at the grant date for stock options issued to employees under SFAS No. 123, the Company's financial statements would have reflected the following amounts:
YEAR ENDED DECEMBER 31, 2000 1999 1998 ---- ---- ---- Additional compensation expense $ 1,108,000 $ 621,000 $ 64,000 Pro forma net loss from continuing operations (8,031,000) (5,569,000) (3,335,000) Pro forma net loss from continuing operations per common share (.60) (.54) (.35)
Pro forma compensation cost for 2000, 1999 and 1998 was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions: expected volatility of 75%, 50% and 30%, respectively; risk-free interest rate of 6.0% for all years; expected life of 7.0, 10.0 and 9.0 years, respectively; and no expected dividend yield for any year. BEST CONNECTIONS OPTIONS--As a result of the Matrix Telecom combination with Best Connections, Inc. ("Best") in 1997, Matrix Telecom assumed the obligation to issue stock options to Best's agents under Best's 1997 Option Plan. Under the New Best Connections, Inc. Amended and Restated 1997 Option Plan, in 1997 the Company issued stock options to purchase 1,292,000 shares of common stock at $1.50 per share to certain distributors and agents of Matrix Telecom. The options were originally granted to facilitate F-18 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 the marketing of residential long distance services. Pursuant to the terms of the option grant, the options became fully vested upon the sale of Matrix Telecom, in November 1999 and expired on May 22, 2000. The Company recorded commission expense, included in discontinued operations, over the vesting period of the option grant totaling $762,000 prior to December 31, 1999. As a consequence of the May 22, 2000 expiration date, 713,000 options were exercised during 2000. The Company realized proceeds from the option exercises of $1.1 million. As of December 31, 2000, all vested options have been exercised or cancelled. The per share weighted average fair value of Best stock options granted on July 1, 1997 was $.59 on the date of the grant using the Black-Scholes option pricing model with the following weighted-average assumptions: expected volatility of 30%, risk-free interest rate of 6.0%, and an expected life of 3.5 years. OPTIONS SUMMARY-Stock option activity is as follows:
WEIGHTED AVERAGE EXERCISE GRANT-DATE OPTIONS PRICE FAIR VALUE Outstanding as of January 1,1998 1,802,000 $1.78 Granted 1,024,000 3.31 $2.63 Expired (47,000) 1.54 Forfeited (107,000) 1.91 Exercised (353,000) 1.81 -------- Outstanding as of December 31, 1998 2,319,000 2.45 Granted 553,000 4.55 3.02 Expired (11,000) 2.40 Canceled (516,000) 3.21 Exercised (295,000) 1.63 -------- Outstanding as of December 31, 1999 2,050,000 2.94 Granted 1,610,000 2.58 1.77 Canceled (962,000) 4.00 Exercised (774,000) 1.50 -------- Outstanding as of December 31,2000 3.07 1,924,000 =========
Total expense recorded for stock based awards during 2000, 1999 and 1998 was $27,000, $561,000 and $477,000, respectively. Total expense associated with continuing operations for stock based awards was $27,000, $157,000 and $373,000 for the same respective periods. F-19 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 The following table summarizes certain information about the Company's stock options at December 31, 2000.
OPTIONS OUTSTANDING ---------------------------------------------- OPTIONS EXERCISABLE WEIGHTED ------------------------------ AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE RANGE OF NUMBER OF CONTRACTUAL EXERCISE NUMBER OF EXERCISE EXERCISE PRICES OPTIONS LIFE PRICE OPTIONS PRICE $ .25 -.38 309,000 9.98 years $ .25 -- $ -- 1.50 - 2.25 232,000 8.81 years 1.89 33,000 2.14 2.31 - 3.31 793,000 8.73 years 3.16 113,000 3.16 4.00 - 6.00 576,000 7.82 years 4.76 180,000 4.65 8.00 - 12.00 14,000 5.63 years 10.73 14,000 10.73 --------- ------- 1,924,000 8.64 years 3.07 340,000 4.16 ========= =======
At December 31, 2000, the Company had reserved a total of 3,505,000 shares for issuance upon conversion of outstanding preferred stock, and exercise of options and warrants. (6) FEDERAL AND STATE INCOME TAXES The provision for income taxes allocated to continuing operations consisted of the following:
YEAR ENDED DECEMBER 31, ----------------------- 2000 1999 1998 ---- ---- ---- Current tax expense (benefit): Federal $ -- $ -- $ -- State and local -- -- -- -------- -------- -------- Deferred tax expense (benefit): Federal -- -- (135,000) -------- -------- -------- Continuing operations $ -- -- (135,000) ======== ======== ======== Discontinued operations $ -- $ -- (1,391,000) ======== ======== ========
Income tax benefit differs from the amounts computed by applying the U.S. federal income tax rate of 34 percent to loss from continuing operations before income taxes as a result of the following:
YEAR ENDED DECEMBER 31, ----------------------- 2000 1999 1998 ---- ---- ---- Computed "expected" tax benefit $ (2,204,000) $ (1,682,000) $ (1,158,000) State and local taxes, net of federal income tax effect (189,000) (183,000) (80,000) Other permanent items (138,000) (145,000) 23,000 Losses not providing tax benefit 2,247,000 2,047,000 1,271,000 Other 284,000 (37,000) (191,000) -------- --------- $ -- $ -- $ (135,000) ======== =========
Deferred income taxes as of December 31, 2000 and 1999, reflect the impact of temporary differences between financial statement carrying amounts and tax bases of assets and liabilities. The tax effects of temporary differences and net operating loss carryforwards that give rise to significant portions of the net deferred tax assets at December 31, 2000 and 1999 are presented below: F-20 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000
DECEMBER 31, ------------ 2000 1999 --------- --------- Deferred tax assets Net operating loss carryforwards $5,322,000 $ 3,919,000 Compensation related items 397,000 416,000 Contingent liabilities and other 395,000 450,000 --------- --------- Gross deferred tax asset 6,114,000 4,785,000 Less valuation allowance (5,436,000) (4,428,000) --------- --------- Deferred tax asset 678,000 357,000 --------- --------- Deferred tax liabilities: Customer base intangible (614,000) (343,000) Covenant not to compete (64,000) -- Other -- (14,000) Deferred tax liabilities (678,000) (357,000) --------- --------- Net deferred tax asset $ -- $ -- ========= =========
The valuation allowance for deferred tax assets increased by $1,008,000, $1,010,130 and $2,233,529 during 2000, 1999 and 1998, respectively. At December 31, 2000, the Company has net operating loss carryforwards for federal tax purposes of approximately $13,747,000 which are available on a limited basis to offset future federal taxable income, if any, through 2020. A portion of these net operating losses may be subject to annual limitations as imposed by Internal Revenue Code Section 382. The valuation allowance recorded in connection with the reverse acquisition of the Company by Matrix Telecom and the acquisition of Remote Lojix, STS and CWE(2) was approximately $3,450,000. If the related deferred tax asset becomes realizable in the future, the reversal of the valuation allowance will be recorded as a reduction of goodwill. (7) RELATED PARTY TRANSACTIONS The Company has had transactions in the normal course of business with various companies who are affiliated with shareholders of the Company. Subsequent to December 31, 2000, a director and several significant holders of the Company's common stock divested themselves of their holdings in Specialized Card. During 1998, a significant number of the Company's employees were leased from United Group Service Center, an affiliate, which provides such services to a number of affiliated companies. This lease agreement was terminated on December 31, 1998, at which time these individuals became employees of the Company. The Company provides long distance and data network service to a number of affiliated companies. Balances with affiliates related to operating activities are settled monthly. In prior years, the Company has made both interest bearing and non-interest bearing advances to affiliated companies. Due from affiliates consists of the following:
Year ended December 31, ----------------------------- 2000 1999 ------- ------- UICI Administrators (UICI) (long distance services) $ 148,000 $ 572,000 Interactive Media Works (IMW) (long distance services) -- 1,000 Core Marketing (long distance services) -- 94,000 AMLI Management Co. (long distance services) 7,000 33,000 Excell Agent Services (long distance services) 114,000 -- Mega Life & Health Insurance (long distance services) 99,000 -- Specialized Card (long distance services) 352,000 -- Student Division (long distance services) 86,000 -- Other receivables from various affiliates 26,000 15,000 ------- ------- $ 832,000 $ 715,000 ======= = =======
F-21 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 Significant services and transactions incurred in the normal course of operations with affiliated companies are summarized as follows:
Year ended December 31, ------------------------------------------- 2000 1999 1998 ---- ---- ---- Revenues include the following: Continuing operations: Long distance revenues from affiliates: See list above $ 4,059,000 $ 4,742,000 $ 4,592,000 ========= ========= ========= Selling, general and administrative expenses include the following: Continuing operations: Expenses incurred for leasing employees from United Group Service Center $ -- $ -- $ 826,051 Overhead expenses reimbursed to/from UGA divisions -- 20,555 30,468 --------- --------- --------- $ -- $ 20,555 $ 856,519 ========= ========= ========= Discontinued operations: Expenses incurred for leasing employees from United Group Service Center $ -- $ -- $ 4,755,377 Sales commissions to affiliates: Core Marketing, UICI, UGA, Best Connections and AMLI -- 30,937 140,187 Overhead expenses reimbursed to UGA/from divisions -- 51,770 211,342 Core Marketing-casual mailings and telemarketing -- 19,668 21,425 --------- --------- --------- -- 102,375 5,128,331 --------- --------- --------- $ -- $ 122,930 $ 5,984,850 ========= ========= =========
In July 1998, the Company purchased notes receivable from one of the Company's significant shareholders at a discount. The notes receivable evidenced loans made by the significant shareholder in 1996 to Matrix Telecom employees to finance their purchases of Matrix Telecom common stock (which was subsequently converted to shares of the Company's common stock). Each of the employees who delivered a note receivable also entered into a Buyback Agreement dated October 6, 1996 (the "Buyback Agreement"), pursuant to which the Company has the option (but not the obligation) to repurchase a portion of such employee's stock upon the termination of his or her employment. The original notes, plus accrued interest, at the date of purchase by the Company were $573,000. The Company purchased these notes for $435,000. In connection with the purchase of the notes receivable above, the Company repurchased 240,912 shares of its common stock subject to the Buyback Agreement from terminated employees. The Company exercised its right to repurchase 225,154 of such shares at a price range of $1.51 to $1.70 per share, and the former employees used the $373,081 in proceeds to reduce the amount of their notes. The Company repurchased an additional 15,758 shares in satisfaction of the remaining balance of $116,085 on the former employees' notes. F-22 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 At January 1, 2000, the total amount owing by one officer of the Company under this note was $91,844. At that time, the note was secured by 30,000 shares of the Company's common stock owned by the officer and bore an interest rate of 6% per annum. In February 2000, the officer paid the note down to a balance of $62,750 and the security for the note was reduced to 15,000 shares of the Company's common stock. In December 2000, the parties reduced the amount of the note to $6,563. The officer then paid this remaining amount through the cancellation of 15,000 of his shares of the Company's common stock. (8) LOSS PER COMMON SHARE Loss per common share is computed as follows: Loss from continuing operations per share -
YEAR ENDED DECEMBER 31, ----------------------------- 2000 1999 1998 ---- ---- ---- Numerator: Net loss $ (6,923,000) $ (4,947,000) $ (3,271,000) Preferred dividends 47,000 304,000 47,000 ----------- ----------- ----------- Loss applicable to common shareholders $ (6,970,000) $ (5,251,000) $ (3,318,000) =========== =========== =========== Denominator: Weighted average number of common shares used in basic and diluted loss per common share 13,700,000 10,795,000 9,633,000 =========== =========== =========== Basic and diluted loss from continuing operations per common share $ (.51) (.49) (.35) =========== =========== ===========
Net loss per share - 2000 1999 1998 ---- ---- ---- Numerator: Net loss $ (6,923,000) $ (2,198,000) $ (5,802,000) Preferred dividends 47,000 304,000 47,000 ----------- ----------- ----------- Loss applicable to common shareholders $ (6,970,000) $ (2,502,000) $ (5,849,000) =========== =========== =========== Denominator: Weighted average number of common shares used in basic and diluted loss per common share 13,700,000 10,795,000 9,633,000 ----------- ========== ========= Basic and diluted net loss per common share $ (.51) $ (.23) $ (.61) =========== =========== ===========
There are 2,137,000, 2,050,000 and 2,319,000 potential common shares excluded from the diluted loss F-23 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 per common share calculation for 2000, 1999 and 1998, respectively, because the effect is determined to be antidilutive. (9) COMMITMENTS The Company leases office space and various equipment under operating leases which expire in various years through 2006. In the normal course of business, operating leases are generally renewed or replaced by other leases. Total rental expense was $614,000 in 2000, $829,000 in 1999,and $546,000 in 1998. Rental expense associated with continuing operations was $614,000, $652,000 and $319,000, in the same respective periods. Future minimum lease payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 2000 are: 2001 - $652,000; 2002 - $533,000; 2003 - $243,000; 2004 - $84,000; 2005 - $60,000; and $7,000 thereafter. In January 2000, the Company entered into a negotiated contractual agreement for switching and transmission facilities committing the Company to $720,000 minimum usage through January 2003. The Company also signed an additional agreement with another supplier in March 2000 for switching and transmission facilities committing the Company to $5,000,000 minimum usage for the life of the contract through March 2002. Based on the Company's rate of usage to date, the Company expects to meet the minimum usage requirements within the life of the contract. (10) LINES OF CREDIT In 1998, the Company entered into a Loan and Security Agreement with Coast Business Credit, which provides for an asset-based revolving credit line with a floating interest rate of prime plus 2%. As a result of the sale of Matrix Telecom, the Company was released by Coast Business Credit and received an indemnity from Platinum from any claims or liabilities relating to borrowings secured by the assets of Matrix Telecom. In March 2000, the Company restructured the secured credit facility with Coast Business Credit. Under the restructured line of credit, the Company may borrow up to 75% of eligible receivables (as defined) and 50% of certain unbilled receivables up to a total amount of $3,000,000. The percentage may be increased to 80% of eligible receivables if the Company reaches certain operational targets. In addition, the line of credit may be used to provide a facility for issuing letters of credit. Borrowings under the line of credit bear interest, payable monthly, based upon the prime rate plus 2% (11.5% at December 31, 2000). Borrowings under the credit facility are secured by substantially all of the Company's assets. As of December 31, 2000, $1,179,000 was outstanding under the credit line and approximately $203,000 was available for future borrowings. The credit facility also prohibits the payment of dividends and limits the size of business acquisitions that the Company may make without the prior consent of Coast Business Credit. During 2000, in connection with the acquisition of STS the Company became liable for their line of credit with and outstanding balance of $91,000 at the date of acquisition. This line, which was secured by all the assets of STS, was repaid in full in early January 2001. Also, in connection with the CWE(2) acquisition, the Company became responsible for a line of credit with a balance of $250,000 at the date of acquisition. This line is secured by all the assets of CWE(2). In December this amount was converted to a term note with payments over two years with interest at the lenders base rate plus .5%, or 11.0% at December 31, 2000. (11) SEGMENT REPORTING The Company's primary business segments are Network Connectivity, Technical Support Services and Application Development and Hosting. The segmentation is based on the types of services provided. All of the Company's services are targeted toward mid-sized businesses and conducted within the United States. F-24 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 The Network Connectivity segment includes services that are point-to-point connections of voice or data traffic. The Company provides traditional long distance services, calling card, dedicated voice and data access and numerous Internet service options. Telecommunications product offerings include dedicated or leased lines, switched long distance, frame relay, ASM, calling cards, and "1-800" services. Internet product offerings within the network connectivity segment include dial-up access, DSL, dedicated access and cable access. This segment includes the Internet connectivity portion of the Company's Southern California based ISP. Technical Support Services segment encompasses a broad array of technical support services and solutions including system integration, desktop and network support, asset management and help desk solutions. Services include flat-fee maintenance contracts, prepaid time block retainers, help desk management contracts, LAN installations, warranty repairs and a small amount of hardware sales. The Applications Development and Hosting services segment includes producing, designing, and programming creative multimedia applications that can be produced as a web application or a stand alone application as well as web hosting services. The Company measures its performance based on revenues, gross margin, net income or loss and earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is not a measure of financial performance under generally accepted accounting principles and should not be considered as an alternative to net income or cash flows from operations, as a measure of performance. The results by segment for the years ended December 31, 2000, 1999 and 1998 are as follows:
2000 TECHNICAL APPLICATION NETWORK SUPPORT DEVELOPMENT CONNECTIVITY SERVICES AND HOSTING CORPORATE TOTAL ------------ ------------ ------------ ------------- ------------ Revenues $ 11,569,000 $ 6,517,000 $ 2,617,000 $ -- $ 20,703,000 Gross margin 3,873,000 2,538,000 1,750,000 -- 8,161,000 Selling, general and administrative expenses 7,118,000 3,797,000 1,504,000 -- 12,419,000 Provision for asset impairment -- -- 298,000 -- 298,000 Depreciation and amortization 610,000 494,000 128,000 -- 1,232,000 Interest expense (78,000) (26,000) -- -- (104,000) Other income (expense) (14,000) (14,000) (5,000) (998,000) (1,031,000) ------------ ------------ ------------ ------------- ------------ Income (loss) before income taxes $ (3,947,000) $ (1,793,000) $ (185,000) $ (998,000) $ (6,923,000) ============ ============ ============ ============= ============ EBITDA (including asset impairment) $ (3,260,000) $ (1,273,000) $ 242,000 (998,000) (5,289,000) ============ ============ ============ ============= ============ Identifiable assets at year end $ 3,815,000 $ 7,567,000 $ 337,000 $ -- $ 11,719,000 ============ ============ ============ ============= ============
F-25 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000
1999 TECHNICAL APPLICATION NETWORK SUPPORT DEVELOPMENT DISCONTINUED CONNECTIVITY SERVICES AND HOSTING OPERATIONS TOTAL ------------ ------------ ------------ ------------- ------------ Revenues $ 9,572,000 $ 5,265,000 $ 2,027,000 $ -- $ 16,864,000 Gross margin 4,305,000 1,895,000 1,281,000 -- 7,481,000 Selling, general and administrative expenses 5,822,000 4,149,000 1,378,000 -- 11,349,000 Depreciation and amortization 426,000 500,000 97,000 -- 1,022,000 Interest expense (26,000) (53,000) (2,000) -- (81,000) Other income (expense) (1,000) 20,000 4,000 -- 23,000 ------------ ------------ ------------ ------------- ------------ Income (loss) from continuing operations before income taxes $ (1,970,000) $ (2,786,000) $ (192,000) $ -- $ (4,948,000) ============ ============ ============ ============= ============ EBITDA from continuing operations $ (1,518,000) $ (2,234,000) $ (93,000) $ -- $ (3,845,000) ============ ============ ============ ============= ============ Identifiable assets at year end $ 4,730,000 $ 5,128,000 $ 656,000 $ -- $ 10,514,000 ============ ============ ============ ============= ============
1998 TECHNICAL APPLICATION NETWORK SUPPORT DEVELOPMENT DISCONTINUED CONNECTIVITY SERVICES AND HOSTING OPERATIONS TOTAL ------------ ------------ ------------ ------------- ------------ Revenues $ 7,997,000 $ 1,011,000 $ 880,000 $ -- $ 9,888,000 Gross margin 3,058,000 399,000 761,000 -- 4,218,000 Selling, general and administrative expenses 5,269,000 846,000 959,000 -- 7,074,000 Depreciation and amortization 482,000 62,000 67,000 -- 611,000 Interest expense (27,000) (1,000) (3,000) -- (31,000) Other income (expense) 77,000 -- 15,000 -- 92,000 Income tax benefit 135,000 -- -- -- 135,000 ------------ ------------ ------------ ------------- ------------ Income (loss) from continuing operations before income taxes $(2,643,000) $ (510,000) $ (253,000) $ -- $ (3,406,000) ============ ============ ============ ============= ============ EBITDA from continuing operations $(2,134,000) $ (447,000) $ (183,000) $ -- $ (2,764,000) ============ ============ ============ ============= ============ Identifiable assets at year end $ 5,163,000 $ 5,430,000 $ 132,000 $ -- $ 10,725,000 ============ ============ ============ ============= ============
(12) CONTINGENCIES The Company is a defendant in a class action lawsuit under the federal securities laws currently pending in the United States District Court of the Central District of California. This litigation is alleging F-26 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 securities fraud as it relates to an unusual upsurge in the Company's stock price and trading volume on November 12, 1998 when trading in the Company's stock was halted by Nasdaq. On October 4, 2000, the Company finalized an agreement with counsel for the plaintiff class to settle all outstanding claims under the class action lawsuit. This agreement received the preliminary approval of the court on November 8, 2000, and the Company thereafter paid $150,000 (including $30,000 in 2000 and $120,000 in 2001) for administrative costs and other settlement implementation expenses. After notification of the settlement class members, the court will hold a hearing, now scheduled for May 14, 2001, to consider the entry of a final order of dismissal and approval of the settlement. If so approved, the Company will then issue for distribution to the claimant class members, and for payment of any plaintiffs attorneys' fees and litigation expenses as the court may award, 232,000 shares of common stock and warrants to purchase 200,000 shares of NetLojix's common stock at an exercise price of $8.00 per share with a term of 2 years. While the Company continues to believe it has strong defenses against the lawsuit, considering the ongoing costs of defending the lawsuit in terms of management time and legal fees as well as the uncertainty associated with a jury trial, the Company believes the settlement is fair and equitable. During the three month period ended March 31, 2000, the Company recorded a charge against earnings of $998,000 and a liability relating to the expected settlement. In connection with the sale of Matrix Telecom (see Note 2), the amount of the purchase price is subject to reduction based upon Matrix Telecom's adjusted stockholders' equity as reflected on a balance sheet of Matrix Telecom at August 31, 1999, prepared by the Company. Platinum has indicated that it materially disagrees with the Company's calculation of the reduction. If the parties are unable to resolve the matter, the contract provides that the calculation will be submitted to an independent firm of accountants chosen by the parties for final resolution. To date, the parties have not agreed on the firm of accountants to resolve the dispute. If the dispute is determined in Platinum's favor, the Company could be required to repay some of the purchase price to Platinum in cash. The Company presently has other contingent liabilities relating to various lawsuits and other matters related to the conduct of its business. On the basis of information furnished by counsel and others, management believes that the resolution of these contingencies will not materially affect the financial condition or results of operations of the Company. F-27 NETLOJIX COMMUNICATIONS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 (13) QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended December 31, 2000 and 1999.
QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER, 30 DECEMBER 31, ----------- ---------- ----------- ----------- 2000 Net revenues $ 5,304,000 $ 5,295,000 $ 4,940,000 $ 5,164,000 Gross margin 2,172,000 2,173,000 2,057,000 1,759,000 Net loss (2,511,000) (981,000) (1,095,000) (2,336,000) =========== ========== =========== =========== Diluted loss per share $ (.20) $ (.07) $ (.08) $ (.16)
QUARTER ENDED MARCH 31, JUNE 30, SEPTEMBER, 30 DECEMBER 31, ----------- ---------- ----------- ----------- 1999 Net revenues $ 3,701,000 $ 4,168,000 $ 4,292,000 $ 4,703,000 Gross margin 1,456,000 1,953,000 2,048,000 2,024,000 Loss from continuing operations (1,565,000) (1,078,000) (1,065,000) (1,239,000) Net income (loss) (3,066,000) (2,121,000) (1,531,000) 4,520,000 =========== ========== =========== =========== Diluted income (loss) per share $ (.29) $ (.22) $ (.15) $ (.40)
F-28 NETLOJIX COMMUNICATIONS, INC., AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
BALANCE AT BALANCE BEGINNING AT END OF PERIOD ADDITIONS DEDUCTIONS ACQUISITION OF PERIOD Allowance for doubtful accounts and other provisions - years ended: December 31, 2000 $ 290,000 $ 551,000 (a) $317,000 (b) $41,000 (d) $ 565,000 ========= ========= ======== =========== ========= December 31, 1999 249,000 296,000 (a) 255,000 (b) -- 290,000 ========= ========= ======== =========== ========= December 31, 1998 156,000 384,000 (a) 291,000 (b) -- 249,000 ========= ========= ======== =========== ========= Valuation allowance for deferred tax asset: December 31, 2000 $4,428,000 $1,008,000 (c) $ -- -- $5,436,000 ========= ========= ======== =========== ========= December 31, 1999 3,418,000 1,010,000 (c) -- -- 4,428,000 ========= ========= ======== =========== ========= December 31, 1998 1,185,000 2,233,000 (c) -- -- 3,418,000 ========= ========= ======== =========== =========
(a) Charged to selling, general and administration expense. (b) Amounts written off. (c) Recognized as a component of deferred tax assets. (d) Allowance for receivables of acquired companies. S-1 INDEX TO EXHIBITS NUMBER EXHIBIT 2.1 Acquisition Agreement, dated as of August 30, 1996, by and among Hi-Tiger International, Inc., a Utah corporation, NetLojix Communications, Inc., a Utah corporation, and NetLojix Holdings, Inc., a California corporation. (Incorporated by reference to Exhibit A to Registrant's Information Statement on Schedule 14C dated October 2, 1996, File No. 0-27580). 2.2 Amendment No. 1 to Acquisition Agreement, dated as of October 22, 1996, among Hi-Tiger International, Inc., NetLojix Communications, Inc., a Utah corporation, and NetLojix Holdings, Inc., (Incorporated by reference to Exhibit 2.2 to Registrant's Current Report on Form 8-K dated October 23, 1996, File No. 0-27580). 2.3 Stock Exchange Agreement, dated as of April 29, 1997, by and between the Registrant and Matrix Telecom, Inc. (Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated April 30, 1997, File No. 0-27580). 2.4 Amendment to Stock Exchange Agreement, dated as of August 25, 1997, by and between the Registrant and Matrix Telecom, Inc. (Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated August 25, 1997). 2.5 Agreement and Plan of Merger, dated as of October 3, 1997, between NetLojix Communications, Inc., a Delaware corporation and NetLojix Communications, Inc., a Utah corporation. (Incorporated by reference to Exhibit 2.7 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 2.6 Stock Purchase Agreement, dated as of July 22, 1998, among the Registrant and the shareholders of Remote Lojix/PCSI, Inc. (Incorporated by reference to Exhibit 2.6 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-27580). 2.7 First Amendment to Stock Purchase Agreement, dated as of August 18, 1998, among the Registrant and the shareholders of Remote Lojix/PCSI, Inc. (Incorporated by reference to Exhibit 2.7 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-27580). 2.8 Earnout Agreement, dated as of October 30, 1998, among the Registrant and certain shareholders of Remote Lojix/PCSI, Inc. (Incorporated by reference to Exhibit 2.8 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-27580). 2.9 Stock Purchase Agreement dated August 31, 1999, among AvTel Communications, Inc., Matrix Telecom, Inc. and Energy TRACS Acquisition Corp. (Incorporated by reference to Exhibit 2.1 to Registrant's Current Report on Form 8-K dated September 8, 1999). 2.10 First Amendment to Stock Purchase Agreement dated as of September 16, 1999, among NetLojix Communications, Matrix Telecom, Inc. and Matrix Acquisition Holdings Corp. (Incorporated by reference to Exhibit 2.2 to Registrant's Current Report on Form 8-K dated December 8, 1999) 2.11 Agreement and Plan of Reorganization dated as of September 19, 2000, among the Registrant, CW Electronic Enterprises, Inc., CWE Acquisition Corporation and Duane E. Werth and Karen L. Werth. (Incorporated by reference to Exhibit 2.1 to Registrants Current Report on Form 8-K dated September 22, 2000) 3.1 Certificate of Incorporation of the Registrant, as amended. (Incorporated by reference to Exhibit 3.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, File No. 0-27580). 3.2 By laws of the Registrant. (Incorporated by reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997, File No. 0-27580). 10.1 Rights Agreements dated October 23, 1996, between the Registrant and holders of the Registrant's Series A Convertible Preferred Stock. (Incorporated by reference to Exhibit 4.2 to Registrant's Current Report on Form 8-K dated October 23, 1996, File No. 0-27580). E-2 10.2 1997 Stock Incentive Plan. (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement on Schedule 14A dated January 8,1997, File No. 0-27580). 10.3 1998 Stock Incentive Plan, as amended. (Incorporated by reference to Exhibit 10.4 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 0-27580). 10.4 New Best Connections, Inc. Amended and Restated 1997 Option Plan. (Incorporated by reference to Exhibit 4.2 to Registrant's Registration Statement on Form S-8 dated May 22, 1998, File No. 333-53435). 10.5 First Amendment to New Best Connections, Inc. Amended and Restated 1997 Option Plan (Incorporated by reference to Exhibit 10.5 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-27580). 10.6 Registration Rights and Lockup Agreement dated December 1, 1997, between the Registrant and Matrix Telecom, Inc., on behalf of the stockholders of Matrix, (Incorporated by reference to Exhibit 4 to Registrant's Current Report on Form 8-K dated December 1, 1997, File No. 0-27580). 10.7 Triple Net Real Property Lease (Multi-Tenant Building) dated as of February 16, 1998, by and between Bath Street Partners, a California limited partnership and the Registrant. (Incorporated by reference to Exhibit 10.8 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1997, File No. 0-27580). 10.8 Amended Loan and Security Agreement dated as of May 30, 2000, among NetLojix Communications, Inc, Remote Lojix/PCSI, Inc., NetLojix Telecom, Inc. and Coast Business Credit. (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, File No. 0-27580). 10.9 Convertible Preferred Stock and Warrants Purchase Agreement dated as of April 5, 1999, among Registrant, AMRO International, S.A., Austinvest Anstalt Balzers, and Esquire Trade & Finance Inc. (Incorporated by reference to Exhibit 10.13 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-27580). E-3 10.10 Registration Rights Agreement dated as of April 5, 1999, among Registrant, AMRO International, S.A., Austinvest Anstalt Balzers, and Esquire Trade & Finance Inc. (Incorporated by reference to Exhibit 10.14 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-27580). 10.11 Stock Purchase Warrants granted by Registrant to AMRO International, S.A., Austinvest Anstalt Balzers, and Esquire Trade & Finance Inc. as of April 5, 1999. (Incorporated by reference to Exhibit 10.15 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1998, File No. 0-27580). 10.12 Private Equity Line of Credit Agreement dated as of April 23, 1999, between the Registrant and Cambois Finance, Inc. (Incorporated by reference to Exhibit 10.1 to Registrant's Current Report on Form 8-K dated May 3, 1999, File No. 0-27580). 10.13 Registration Rights Agreement dated as of April 23, 1999, between the Registrant and Cambois Finance, Inc.(Incorporated by reference to Exhibit 10.2 to Registrant's Current Report on Form 8-K dated May 3, 1999, File No. 0-27580). 10.14 Stock Purchase Warrants granted by Registrant to Kaufman Bros., L.P. as of January 10, 2000. (Incorporated by reference to Exhibit 10.15 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 0-27580). 10.15 Common Stock and Warrants Purchase Agreement dated as of March 2, 2000, between Registrant and AMRO International, S.A. (Incorporated by reference to Exhibit 10.16 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 0-27580). 10.16 Registration Rights Agreement dated as of March 2, 2000, between Registrant and AMRO International, S.A. (Incorporated by reference to Exhibit 10.17 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 0-27580). 10.17 Stock Purchase Warrants granted by Registrant to AMRO International, S.A. as of March 3, 2000. (Incorporated by reference to Exhibit 10.18 to Registrant's Annual Report on Form 10-K for the year ended December 31, 1999, File No. 0-27580). E-4 10.18 Stipulation of Settlement dated as of October 4, 2000, among the Registrant and the representative plaintiffs in the securities class action pending in the United States District Court for the Central District of California (IN RE AVTEL SECURITIES LITIGATION, Case No. 98-9236). (Incorporated by reference to Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000). 10.19 Second Amended and Restated Promissory Note dated December 12, 2000 between the Registrant and Joseph Renteria, Jr. and related Stock Pledge Agreement dated February 29, 2000 between the Registrant and Joseph Renteria, Jr. 10.20 Promissory Note dated December 2, 1998, of Craig R. Clark to the Registrant, and Promissory Note dated November 17, 2000, of Craig R. Clark to the Registrant. 21 List of Subsidiaries 23.1 Consent of Ernst & Young LLP, Independent Auditors 23.2 Consent of KPMG LLP E-5